Option Investor


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The Bears Are Calling!

If anyone raises an eyebrow and asks you why your hands are always on your lap, here's a plausable explanation you can use. A Reuters New Service article says that an estimated "11,300 laptop computers, 31,400 hand-held computers and 200,000 mobile phones were left in taxis around the world in the last six months."

Doesn't that say something about one's sense of awareness? In business, as well as in our daily lives, these are all items we depend on. Add that to the fact that these devices "ain't cheap" and it makes you wonder about people who can't even monitor the whereabouts of their possessions. These are not potentially successful option traders where a sense of awareness is crucial. As traders, their money would disappear faster than you can say, "market order."

At a Couch Potato Trading Institute Student we need to monitor certain things -- the couch, the television, the remote, the refrigerator, the phone, the computer and the status of our option positions -- not necessarily in that order. Remember, without our option profits, we'd actually have to work and your couch, television, remote and refrigerator would have to be alone all day.

There can be any number of reasons your hands are in your lap. Keeping track of what is essential to your existence is a particularly good one. If you can't keep track of your possessions, you may still end up being a trader. But you'll be trading food stamps for no-brand Cheerios.

By the way, other items left in cabs included a harp, dentures and artificial limbs. Gee, how could someone live without his harp?_______________________________________________________________________________

The Bear Call Spread
A bear call spread is the evil twin of the bull put spread. It's like the bull put spread, but upside down. It consists of selling a call and then purchasing a call at a higher level for the same expiration cycle. It's called a "bear call" spread because we are bearish and we're using calls. Once again, we will be taking in premium when we sell the call and then spending less premium when we buy the long call. For example, with the RUT trading at 637.44.

a) sell a RUT March 670 call for $1.90 ($190 per contract)
b) buy a RUT March 680 call for $1.20 ($120 per contract)

If we only sold the 670 call, we would have unlimited exposure to the upside. 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 call. 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 $.70 more than we spent. That's ours to keep. If RUT closes, at expiration, below 670, both the short 670 call and the long 680 call will expire worthless. Remember, the concept of "worthless" has a negative connotation. 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 the objective.

Your exposure in a bear call spread is the difference between the strike prices. In the above example, you're exposed for 10 points (670 - 680) or $1,000 per contract. Your real risk is a little less. Remember, you took in $.70 ($70) of premium that you didn't have before. So, your out-of-pocket risk is only $930 ($1,000 - $70). That is the worst-case scenario.

In the above example, you will make money if RUT goes down, remains the same, or even goes up 37 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 below 670? This is the perfect result. Both the short 670 call and long 680 call will expire worthless and the $.70 ($70) premium you received is safe and sound and we all live happily ever after -- at least until we run out of money.

b) . . . RUT finishes at 690? This is the worst-case scenario. The RUT spiked all the way up through the short 670 call and continued on up through the long 680 call. 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 $70 premium received).

c) . . RUT finishes at 672.50? The 680 long call will expire worthless, but the short 670 call will have intrinsic value of $2.50. This $2.50 ($250 per contract) will be deducted from your brokerage account on Monday after expiration. Don't forget, though, you took in $70 per contract. Therefore, your out-of-pocket loss is only $1.80 ($180 per contract).

Always calculate your breakeven point. With a bear call spread, it's the short strike price (670) plus the premium received ($.70) -- 670.70. Below the BE point, you make money. Above the BE point, you don't. The BE points above are based on where RUT finishes at expiration. At expiration, all the time value will have eroded away and all that is left is intrinsic value (if any). During the life of the play, the BE point can vary dramatically. From the time you put on the bear call spread, the breakeven point will change dramatically -- along with the bids and asks on your long and short positions.

To calculate exactly where you stand at any point in time, just figure out what it would cost to buy back your short call and how much you could get when you sell your long call. Until time as passed and premium has time to erode away, it will cost you substantially more to close your position that the premium you received when you initially put on the spread.

Next: Combining the bull put and bear call spreads.


February Position #1 - SPX Iron Condor - 1205.30
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 - 577.17
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 - 474.04
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 - 1205.30
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 - 474.04
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 - 1205.30
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 approximate 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 going to use the entire $26,000 of extra cash as maintenance for some Iron Condors. That should enable us to generate substantially more profit on this "no risk" strategy.

February Zero Plus Iron Condor Position - SPX - 1205.30
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 - $37.70
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. _____________________________________________________________________________

Are You A Serious Trader?
Look at your brokerage account. Is it where you'd like it to be? How many of your trades are profitable?

Dou want to learn how to position yourself to take advantage of those directional traders who lose their money betting on whims or recommendations? Of course you do. It's relatively easy pickins -- if you have what it takes to harvest the crop.

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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