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DANCING ON A MINEFIELD

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SO YOU WANT TO GO ?

The only thing more dangerous than skydiving without a parachute is a new option trader with a checkbook. It's been said that a fool and his parachute are soon parted. Let's see if we can pull in the reins on that checkbook before the money takes flight. Directional traders (bless them all) contribute to our coffers monthly when they place their bets and watch their dollars disappear into our pockets. But, even though we make our money selling options, selling options can be dangerous as well -- IF you don't know what you're doing.

CPTI students have written asking about why we buy the out of the money wings on our Iron Condors and Siamese Condor trades. It's called self-preservation. However, for those who like to walk on the wild side, there are ways to head off disaster. Catastrophes - we can't control. But, we can dodge a small caliber bullet or two, if we have to. But, trading uncovered options is like taking a knife to a gunfight.

The Short Strangle

The Short Strangle consists of the sale of a put and a call with different strike prices, but the same expiration month. It is a neutral strategy. The objective is for the stock to finish, at expiration, between the sold strikes. The two options will then expire worthless, you'll keep all the credit and live happily ever after.

The Short Strangle is really the Iron Condor's evil twin. Our old friend, the Iron Condor, is simply a Short Strangle that has protection in the form of long puts and calls purchased one strike further out-of-the-money respectively.

Let's look at an example. Keep in mind that this example is hypothetical and for educational purposes only. It is NOT intended as a recommendation.

GOOG (Google) closed Friday at $192.05. For this example, we'll use a 10-contract position. Now, I repeat, this is an EXAMPLE -- NOT A CPTI PORTFOLIO TRADE. I can't make it any clearer than that, but I guarantee I'm still going to get emails.

Putting On The Trade - This is the easy part. The only requirements are that you're breathing, have a checkbook and are two sandwiches short of a picnic. Plus, you must have the highest trading approval level from your brokerage firm to trade "uncovered" options. Brokerage firms usually assign this level only to traders who have extensive experience and who have substantial assets. A decent size brokerage account will be necessary to satisfy maintenance requirements.

Sell 10 contracts of the GOOG May $230 calls @ $.80 = $800

Sell 10 contracts of the GOOG May $160 puts @ $.80 = $800

Total amount of credit taken in = $1,600

Your Exposure -

Both the sold puts and calls are uncovered. The puts (and you) are exposed from the sold strike ($160) down to zero while the calls have unlimited exposure from the sold strike ($230) to the moon. Now that may sound a little melodramatic, but technically it's true. That's why brokerage firms are careful about handing out "uncovered" approval levels. Inexperienced traders are less likely to know how to make necessary adjustments when an "uncovered" option strike is threatened or violated.

There are horror stories about traders who lost six figures trading naked options. Then, they turned around and sued the brokerage firms who allowed them to trade - and WON! Unbelievable! There are plenty of slip-and-fall-give-me-a-call attorneys who now specialize in stock market cases. That's a pretty sad commentary on the human condition -- people doing stupid stuff and then looking to blame someone else.

Maintenance

If you are able to put on the Short Strangle trade, your brokerage firm will want to hold some money, or assets, in your account for their (and your) protection. The stock price is part of the equation, so the requirement will vary daily as the stock price moves. This is money you will need to leave in your brokerage account in the form of cash or other marginable securities.

It's also important that you have an account with one of the more progressive brokers. To make the most efficient use of your trading capital, you want a broker who will hold maintenance on only one side of the strangle. If you are still with the old school brokers (Schwab, Fidelity, Preferred, Interactive, etc.), and want a few progressive broker names to explore, simply send me an email (mparnos@optioninvestor.com).

The Formula

Here is how to calculate the maintenance requirement for naked positions. GOOG at $192.


The initial margin requirement for the transaction is 20% of the underlying stock plus the credit received, less the amount out of the money.

20% of the value of the underlying ($192) = $38.4
Add premium received from the May $25 call: $.80
Total: $39.20 ($38.4 + $.80)
Subtract amount out-of-the-money: $32.00 = $7.20 ($39.20- $32.00)
Margin Requirement: $7.20 x 100 = $720 per contract
For a 10 contract position: $7.20 x 10 contracts = $7,200

Since we're putting on TWO uncovered positions, we have to calculate both sides and the maintenance held is the HIGHER of the two figures. The maintenance amount will vary day to day as the underlying (GOOG) moves up and down. If GOOG moves against you, the brokerage firm will require additional funds for maintenance.
Also, if the calculated results are less than 10% of the value of the underlying ($23), the maintenance figure will default to 10%.

Adjustments
When the stock is about to violate one of the sold strikes or an important support or resistance level, you have to be prepared to act. This is your first line of defense. You can (using the short call as an example):
1. Close out the short position by buying back the short call.
2. Roll the short call out to a later month at a higher strike. You may have to increase the number of contracts to make up the deficit.
3. Close out the short call position and sell an additional number of puts to make up the deficit.
4. Buy an appropriate number of shares of stock to cover the short call.
5. Buy a deep in-the-money call to cover the short call.

Well, there it is -- the Short Strangle. For all its glory, it's risky, but if you have the approval level, and you find a stock with a nice wide trading range, you can generate a nice monthly cash flow.


Whatever you do, think it through. Know the strategy inside and out. Whatever you decide, have a plan in place for either outcome. If the trade moves against you, you'll be prepared. If it works, you can afford to stay at home for the next three days and watch the Home Shopping Network - and maybe even buy something.

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APRIL CPTI POSITION UPDATE

With four trading days left (five on CME) for our April positions, we're looking pretty good. Remember, we already have $2,770 in our pocket from closing our OSX Calendar Spread and SPX Sure Thing positions early this week. We can bank a potential additional $4,500 in profit if our remaining MSH, CME and SPX positions expire within our ranges. I like our chances.

QQQQ ITM Strangle Rollout

On Friday afternoon, with the QQQQs comfortably between $36 and $37, we bought back our short April options and rolled them out for a net credit of $.95 ($950). We are now short the May $36 puts and the May $37 calls.

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NEW SUMMER SEMINAR DATE: JULY 16 & 17 -- PHILADELPHIA, PA

WE'VE HAD 27 OUT OF 28 PROFITABLE MONTHS -- WITH NO END IN SIGHT.

COME LEARN HOW TO ACHIEVE SUCCESS WITHOUT STRESS WITH CPTI WEALTH-BUILDING TECHNIQUES.

The CHICAGO Mike Parnos CPTI seminar is sold out. However, there are still spots left for the May IRVINE, CA seminar, and now, of course the new PHILADELPHIA, PA seminar. They probably won't last long, so be proactive! That means GOYA. Contact me at mparnos@optioninvestor.com and I'll reserve a spot for you. He who hesitates may be SOL.

The dates and locations are:

April 16/17 - Chicago, IL - SOLD OUT!!!
May 14/15 - Irvine, CA

July 16/17 - Philadelphia, PA

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

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CPTI APRIL POSITIONS
April CPTI Position #1 -- MSH Iron Condor - 453.73
With MSH trading at about 471, we sold 15 MSH 510 April calls and bought 15 MSH 520 April calls for a credit of $.75. Then we sold 15 MSH 420 April puts and bought 15 MSH 410 April puts for a credit of $.45. Our total net credit is $1.20 with a potential profit of $1,800. Maximum profit range is 420 to 510 and the maintenance is $15,000.

April CPTI Position #2 - OSX Calendar Spread -- Closed for $1,500 Profit.
We bought 10 OSX September $150 calls @ $8.30 and sold 10 OSX April $150 calls @ $2.35. Our out of pocket cost is about $5.95 ($5,950).

Our price target for the next six weeks is about $150. If we're right, we should make a nice chunk of change. Even if OSX goes nowhere, we will not have risked a great deal. The $2.25 we took in from the short April call will erode away and will help to offset any premium erosion from our long Sept. $150 calls. On Tuesday we closed out this position for a profit of $1,500.

April CPTI Position #3 - CME Iron Condor - 186.37

It's the Chicago Mercantile Exchange-you know, the exchange where people trade futures on grains, gasoline and pork bellies.

We sold 10 CME April 230 calls and bought 10 CME April 240 calls for a credit of about $.60 ($600). Then we sold 10 CME April 165 puts and bought 10 CME April 155 puts for a credit of about $.60 ($600). Our total net credit and profit potential is about $1.20 ($1,200). Our maximum profit range is 165 to 230. Maintenance is $10,000.

April CPTI Position #4 - SPX "Sure Thing" Credit Spread - Closed for $1,270 Profit

We sold 2 SPX April 1215 Calls and bought 2 SPX April 1240 Calls for a credit of about $7.00 ($1,400). This strategy is only for traders who have a very large account and have excess maintenance dollars handy. Our initial maintenance is only $5,000 (25 points x 2 contracts). On Wednesday we closed our position for a profit of $1,270.

April CPTI Position #5 - SPX Iron Condor - 1181.20

We sold 15 SPX April 1125 puts and bought 15 SPX April 1115 puts for a credit of about $.50 ($750). Then we sold 15 SPX April 1250 calls and bought 15 SPX April 1260 calls for a credit of about $.50 ($750). Our total net credit is $1.00 ($1,500). Max profit range: 1125 to 1250. Maintenance: $15,000.

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MAY CPTI NEW POSITIONS

May CPTI Position #1 - SPX Iron Condor - 1181.20
We sold 15 SPX May 1100 puts and bought 15 SPX May 1090 puts for a credit of $.60. Then we sold 15 SPX May 1235 calls and bought 15 SPX May 1245 calls for a credit of $.75. Our total net credit is $1.35 ($2,025). We have a maximum profit range of 1100 to 1235. The bigger the better!! Maintenance is $15,000.

May CPTI Position #2 - CME Iron Condor - 186.37

We sold 15 CME May 155 puts and bought 15 CME May 145 puts for a credit of $.65. Then we sold 15 CME May 230 calls and bought 15 CME May 240 calls for a credit of $.40. Our total net credit and profit potential is $1.05 ($1,575). Our maximum profit range is 155 to 230. The maintenance is $15,000.

May CPTI Position #3 - MID Iron Condor - 655.57

We haven't used MID in the past, so it should be interesting. Due to the fact that it consists of midcap stocks, it should offer us another degree of diversification.
We sold 12 May MID 620 puts and bought 12 May MID 610 puts for a credit of $.65 ($780). Then we sold 12 May MID 700 calls and bought 12 May MID 710 calls for a credit of about $.45 ($540). Our total net credit and profit potential of $1.10 ($1,320). Maximum profit range of 620 to 700. Maintenance is $12,000.

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ONGOING STRATEGIES
ZERO-PLUS Strategy - March Iron Condor Position - SOX - 416.95
Profit: $1,800.

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.

March Zero Plus Position: March SPX Iron Condor - Expired worthless-Profit: $1,800.

New Cash Position: $26,000 + $1,800 = $27,800.

New April Zero Plus Position: We sold 20 of the SOX April 450 calls and bought 20 of the SOX April 460 calls for a credit of $.55 ($1,100). Then we sold 20 SOX April 380 puts and bought 20 of the SOX April 370 puts for $.30 ($600). Our total net credit was $.85 ($1,700). It's a nice wide range with support on the bottom and resistance on the top.

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QQQ ITM Strangle - $36.64
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.

We rolled out our short positions to April. We bought back the March $37 puts and sold the April $36 puts for no credit or debit. It was an even exchange. Then we sold the April $37 calls for $.60 ($600). We had purchased back the March $38 puts last week for $.05. Our net credit for April (at least to begin with) is $550. Add that to our previous cash total of $1,600 and we now have generated a total of $2,100. Now, if the market cooperates . . .

We rolled out our short April options to May. See "update" above.

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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

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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, guess what? It isn't the fault of the strategies.

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