Trading chart pattern from a bull flag turning to a high base with diagonal spread

Sometimes, stock chart patterns do not progress as expected. A bull flag pattern could fail and turn into bearish or flat patterns. With the diagonal spread option strategy, you can continue to benefit from the time decay of the sold option, as long as the stock does not break out of the consolidation range. The premium of the short option is able to cover some of the loss of the long option as a hedge. It may also generate eventual profit for the position if the stock prices stay in the range or move in favor of the long option later.

Here’s a live example of this type of trade. About 3 weeks ago, I started the bull flag breakout trade on PVH with the purchasing of September 15 $95 Call. Then PVH hit resistance level around $104.35 and started to pull back. I sold short May 19 $105 Call after the price dropped for about 2 days in a roll, as posted in 2 live examples of Legging into Diagonal Spreads.

Since then, PVH never rose for over 2 days in a roll which is my guideline to keep the short call (without uncovering it). Today, PVH which is an apparel hold company fell hard intraday along with other retail stocks, as they were sold off in the last couple of days after a couple of bad earning reports. The stock market is concerned about the future prospect of brick and mortar retailers against on-line shops.

After touching the 50 day moving average (DMA) and horizontal support which was a little bit above my mental stop at $97.79, PVH started to bounce up. The short call did meet two of my exit rules:

• Delta reached below 0.10
• Premium dropped over 80%

So, I placed a limit order to buy back the May 19 $105 Call for $0.16 to lock in 80% of its profit. It got filled after a couple of hours.  Now, the cost of the position is $12.22 - $1.00 + $0.16 = $11.22 + $0.16 = $11.38.

Since PVH has its 50 DMA up-trending, the general market is still bullish and PVH outperforms XRT at this moment, I decided to hold the long call for now. The next actions will be based on my plan as follows:

• Exit the long call if the stock price continue to show weakness and breaks below 50 DMA or my mental stop loss point
• Sell another call if the stock price rises, then pulls down for another 2 days in a roll with a declining MACD histogram

We’ll never know the outcome of the trade before the market finally shows it real face as it evolves. At present I think there is still a high probability for this trade to profit and I’m enjoying the diagonal spread trade until proven otherwise.