A bearish bet on Dollar General using Options Spreads Dollar General (DG) has been stuck in a bear trend since November 2022. In the six month daily chart shown below, we can see that the 50-day simple moving average has been acting as an area of strong resistance. Every time the stock approaches this level, it gets rejected. The 50-day average as of today is currently around $120. And although DG has experienced some upward momentum since mid-October, this upward momentum is now facing resistance once again at the 50-day average. To provide further confirmation for a bearish bias, I am using 2 technical indicators in the chart below: RSI (Relative Strength Index): You will notice that RSI was rising from 10/12 to 10/26 as DG was experiencing a short-term rally. Starting on 10/26, RSI has changed direction and is pointing down, indicating that the stock is losing its upward momentum. DMI (Directional Movement Index): a) When the DI+ (green line) is above DI- (red line), the stock is in an uptrend. However, when the DI lines start changing direction, it indicates a possible change in the current trend. b.) ADX (blue line) measures the strength of the current trend. If you look at ADX, it is pointing downwards indicating the current trend in place (uptrend as indicated by DI+ being above DI-) is weakening. This further provides confirmation to form a bearish bias on DG The Trade Setup: A Bear Put Spread Now that I have a directional bias in place, all I need to do is find a trade structure which will allow me to bet on a downward move in DG. The trade structure I am going to use here is called a “bear put spread” also known as a “put debit spread.” If you look at DG’s option chain, you will notice that this is a highly liquid stock with $1 wide strikes. This is great, because you can construct a $1 wide put spread and risk as little as $50 to make $50 per winning trade. To increase risk, simply add more contracts. Eg. Doing a 50 contract trade would risk $2500 to make $2500. All I need is for DG to drop by $1 by expiration date for this trade to be profitable. Here is the exact trade setup: Buy $120 put Nov 17 expiry Sell $119 put Nov 17 expiry A nice thing about buying ATM (at-the-money) spreads, is that the math becomes very easy. ATM spreads can usually be bought for ½ of the width of the strikes. Since the width of our spread is $120 – $119 = $1, I can buy the spread for .50c. DG YTD mountain Dollar General, YTD If DG is trading at 119 or below on expiration date, this trade will double my money. Managing losses A very important part of any profitable trading system is that it needs to have positive expectancy. That means the winners need to add up to more than the losers. For me, to create positive expectancy with this trading strategy, I will close this trade if I lose 50% of my investment (i.e. 25c). By simply doing this, every winner will cancel out two losing trades. DISCLOSURES: Nishant currently has a DG 120-119 put spread expiring on 12/1/2023 THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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