Option Investor


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There are a number of new subscribers to the Couth Potato Trader. Where did they come from? Believe it or not, our reputation of success is spreading faster than mozzarella in a deep dish pizza. Many new subscribers are directional traders who are tired of donating their money to the Church of the Almighty Coin Flip. Then, there are escapees from other subscription services who recognize the value of our approach and want to learn more about option selling.

As option sellers, we're experiencing a premium draught. With the low volatility envirnoment we've had for quite some time, finding option premium in today's market is like trying to find a curve on Lara Flynn Boyle. There's a little there, but is it worth the effort?

Our favorite strategy is the Iron Condor. It's a neutral or non-directional strategy that creates a scenario allowing the underlying asset (index or stock) to move up, down or stay the same and still pocket a very nice profit.

The Iron Condor is a combination of two credit spreads -- a bull put spread and a bear call spread. Since both the bull put spread and bear call spreads are credit spreads, we will be "collecting" premium from the market -- not spending it. The challenge comes in determining the spread sizes, the placement, and the amount of premium to be taken in -- all the while remembering the importance of safety. Over the next few columns, we'll be taking a closer look at the Iron Condor -- it's components and how they work. We're going to start with the bull put spread.

The Bull Put Spread
A bull put spread consists of selling a put and then purchasing a put at a lower level for the same expiration cycle. It's called a "bull put" spread because we are bullish and we're using puts. See, some of this stuff actually makes sense. We will be taking in premium when we sell the put and then spending less premium when we buy the long put. For example, with the RUT trading at 637.44.

a) sell a RUT March 590 put for $2.10 ($210 per contract)
b) buy a RUT March 580 put for $1.30 ($130 per contract)

If we only sold the 590 put, we would have unlimited exposure all the way down to zero. That's dangerous. Plus, most option traders will not have the trading approval level from their brokerage that will allow them to sell "uncovered" or "naked" options. So, to protect us from the market, and from ourselves, we will have to buy some protection -- in the form of a long put. Think of it as a financial condom that helps prevent traders from prematurely giving birth to empty brokerage accounts.

You'll notice that we have taken in $.80 more than we spent. That's ours to keep. If RUT closes, at expiration, above 590, both the short 590 put and the long 580 put will expire worthless. In most segments of society, the concept of "worthless" has a negative connotation (as in my ex-brother-in-law). However, if you're an option seller, you're benefiting from the passage of time. Why? With the passage of time, the value of the option you sold is eroding away -- hopefully to zero. And -- your obligation to perform is eroding away along with the premium. That's a good thing.

Your exposure in a bull put spread is the difference between the strike prices. In the above example, you're exposed for 10 points (590 - 580) or $1,000 per contract. Your real risk is a little less. Remember, you took in $.80 ($80) of premium that you didn't have before. So, your out-of-pocket risk is only $920 ($1,000 - $80). That is the worst case scenario.

In the above example, you will make money if RUT goes up, remains the same, or even goes down 47 points. You have a much better chance of success. Why try to guess a direction if you don't have to?

What If . . .
a) . . . RUT finishes anywhere above 590? This is the perfect result. Both the short 590 put and long 580 put will expire worthless and the $.80 ($80) premium you received is safe and sound and we all live happily ever after.

b) . . . RUT finishes at 550? This is the worst-case scenario. The RUT tanked all the way through the short 590 put and continued on down through the long 580 put. If this happens, without you making an adjustment, you will lose the difference between the strike prices ($10 or $1,000 per contract -- less the $80 premium received).

c) . . RUT finishes at 586.50? The 580 long put will expire worthless, but the short 590 put will have intrinsic value of $3.50. This $3.50 ($350 per contract) will be deducted from your brokerage account on Monday after expiration. Don't forget, though, you took in $80 per contract. Therefore, your out-of-pocket loss is only $2.70 ($270 per contract).

Always calculate your breakeven point. With a bull put spread, it's the short strike price (590) less the premium received ($.80) -- 589.20. Above the BE point, you make money. Below the BE point, you don't.

Next: The Bear Call Spread

Going With The Flow . . .
If you haven't already put on out "hypothetical" March positions, you should consider adjusting the strike prices. The market shot higher on Friday and made the 1250/1260 strikes appealing for the bear call spread. The bull put spread could conceivably be raised to about 1130/1120. You might have to wait for a pullback before sufficient premium will be available in the 1130/1120.

Notice that there aren't any strike prices available (at this writing) from 1130 to 1150. That will probably change in a few days, but remember that, even though you may want to put on a position now, you should never compromise safety for convenience or higher premium.

February Position #1 - SPX Iron Condor - 1203.03
We sold 10 SPX Feb. 1255 calls and bought 10 SPX Feb. 1265 calls for a credit of about: $.50 ($500). Then we sold 10 SPX Feb. 1140 puts and bought 10 SPX Feb. 1130 puts for a credit of about: $1.00 ($1,000). Our total net credit was $1.50 ($1,500). Maintenance of $10,000. We've created a maximum profit range of 1140 to 1255 -- that's 115 points. If everything works out as planned, our return on risk will be 17.6%. We're still conservative and defensive minded. That's why we're limiting our spread size to 10 points or less.

February Position #2 - OEX Bull Put Spread - 575.09
We sold 15 OEX Feb 530 puts and bought 15 OEX Feb 520 puts for a credit of about $.50 ($750). Our net credit and potential profit is $750. Maintenance of $15,000. We're going to be content to put on the bull put spread for now. If/when the time is right, we'll put on the bear call spread to complete the Iron Condor.

February Position #3 - MSH Iron Condor - 475.78
We sold 10 MSH February 430 puts and bought 10 MSH February 420 puts for a credit of about $.60 ($600). Then we sold 10 MSH February 510 calls and bought 10 MSH February 520 calls for a credit of about $.55 ($550). We have a net credit and profit potential of about $1.15 ($1,150). Our maximum profit range is 430 to 510. 510 looks like solid resistance and 430 is comfortably below other support levels. Maintenance is $10,000.

February Position #4 - SPX Iron Condor - 1102.03
We sold 10 SPX February 1230 calls and bought 10 SPX February 1240 calls for a credit of about $.40 ($400). Then we sold 10 SPX February 1120 puts and bought 10 SPX February 1110 puts for a credit of about $.65 ($650). Our total credit and potential profit is$1.05 ($1,050.) We've created a maximum profit range of 1120 to 1230. Maintenance of $10,000.

March CPTI Position #1 -- MSH Iron Condor - 475.78
The Morgan Stanley High Tech Index has bounced around a bit, but it has some pretty well defined support and resistance levels. The market seems to have settled back into a trading range. Let's hope it behaves.

We sold 10 March MSH 430 puts and bought 10 March MSH 420 puts for a credit of about: $.90 ($900). Then we sold 10 March MSH 510 calls and bought 10 March MSH 520 calls for a credit of about $.35 ($350). Our total approximate credit and potential gain of $1.25 ($1,250). We've established a maximum profit range of 430 to 510. The maintenance is $10,000. The actual exposure is $8,750 ($10,000 less the $1,250 premium received).

March CPTI Position #2 -- SPX Iron Condor - 1203.03
We sold 15 March SPX 1120 puts and bought 15 March SPX 1110 puts for a credit of about: $.50 ($750). Then, we sold 15 March SPX 1240 calls and bought 15 March SPX 1250 calls for a credit of about: $.70 ($1,050). Our total appx. credit and potential gain of $1.20 ($1,800). We've established a maximum profit range of 1120 to 1240. The maintenance is $15,000. The actual exposure is $13,200 ($15,000 less the $1,800 premium received)..


ZERO-PLUS Strategy -
In my Feb. 8, 2004 column, I outlined a strategy based on an initial investment of $100,000. $74,000 was spent on zero coupon bonds maturing in about seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We're trading the remaining $26,000 to generate a "risk free" return on the original investment.

This year, we're using the entire $26,000 of extra cash as maintenance for Iron Condors. That should enable us to generate substantially more profit on this "no risk" strategy.

February Zero Plus Iron Condor Position - SPX - 1203.03
We'll start with our February position #4. However, we're going to sell 20 contracts of the SPX 1120/1110 bull put spread and buy 20 contracts of the SPX 1230/1240 bear call spread for a net credit $1.05 -- giving us a potential profit of $2,100.


QQQ ITM Strangle - $37.75
We own 10 January 2007 $42 puts and 10 January 2007 $32 calls at a total cost of $14,600. Only $4,600 is at risk as the other $10,000 of intrinsic value will always be there. We then sold the March $36 puts and $38 calls, taking in a total of $1.10 ($1,100). If all goes well, the QQQQs will close somewhere between $36 and $38. We will then sell the April near term options, etc. etc. The objective is to sell premium every month for the next 22 months. When all is said and done, we should be able to show a very nice profit.


Jacksonville -- Just The First Stop
This weekend the eyes of America will be focused on Jacksonville, FL. The New England Patriots will be slugging it out with the Philadelphia Eagles at the Superbowl. In mid March, the eyes of America will again be focused on Jacksonville. Why? Because that's the location of the first of three Spring Mike Parnos CPTI seminars. Jacksonville will be the first stop of the CPTI Profit Train.

Since I announced the three seminar dates last week, I've been inundated with over 50 responses by folks who want to reserve spots. I'm going to take a leap of faith and assume you are serious options traders or you wouldn't be reading my CPTI newsletter. You want to learn how to position yourself to take advantage of all those directional traders who lose their money betting on whims or the recommendations of others.

Options are marvelous tools -- but you have to know how to use them. There's more to consistently making money than a coin flip and a mouse click. For less than the profit on one Iron Condor trade, you can learn how to put the percentages in your favor. It's knowledge that will last you a lifetime. Join me at one of my CPTI seminars. The dates and locations are:

March 19/20 - Jacksonville, FL
April 16/17 - Chicago, IL
May 14/15 - Irvine, CA

Send me an email at mparnos@optioninvestor.com and I'll forward you all the details. The spots are filling up fast. Don't be left out! It'll be a weekend you'll never forget!

Happy Trading!
Remember the CPTI credo: May our remote batteries and self-discipline last forever, but mierde happens. Be prepared! In trading, as in life, it's not the cards we're dealt. It's how we play them.

Mike Parnos, Your Options Therapist and CPTI Master Strategist _____________________________________________________________________________

Couch Potato Trading Institute Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, it ain't the fault of the strategies.

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