Can Price Movement Be Explained by Profit-Taking?: A Real-Life Example with Global X Funds Infrastructure Dev. (PAVE)
On April 8,2021, Nathan shared with me his covered call writing trade with PAVE which was initiated 3 days earlier. This exchange-traded fund had a strong technical chart but the price started declining immediately after the trade was entered. Nathan commented that he read in a technical analysis book that when share price breaks out above resistance, there will be at least 1 profit-taking event that will bring it back to the breakout point. Was this the case here? Should the option be rolled-down? Should the stock be sold? Something else?
Nathan’s trade with PAVE
- 4/5/2021: Buy PAVE at $25.53
- 4/5/2021: STO the April 16, 2021 $27.00 call at $0.15
- 4/6/2021 – 4/7/2021: Stock price declines to $24.81 and recovers to $25.11
- We will explore a 3-month price chart
3-month price chart of PAVE
- Red arrow: Breakout above resistance about March 10th
- Blue arrow: Price drops from above resistance down to support
- Green arrow: Price recovers to but not above resistance
- Currently the price is looking for direction
Trade analysis
It is possible that profit-taking played a role in share price decline on April 6th – 7th. Whipsaws with a security like PAVE are somewhat predictable when looking at its implied volatility which is more than double that of the S&P 500. Nothing wrong with that but it does explain price movement. This is a good example as to why BCI implemented the 20%/10% guidelines as when to close our short calls. Rather than trying to figure out “why” (which can be quite challenging at times), we can determine “when”
Discussion
PAVE closed on Friday April 9th at $25.35 with a trade breakeven at $25.38. Final results can go either way. At this point in time, the best action may be no action at all.