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THE BID & ASK SPREAD - EXPOSED - PART II

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THE BID & ASK SPREAD - EXPOSED - PART II

Last Sunday we started talking about the bid ask spread. Let's keep right on going. If you didn't read it, go back to last Sunday's (6-5-05) and read it. If you don't, the following information isn't going to make much sense to you.

Doing The Detective Work
In order to get the most premium, you're going to have to work for it. I still get emails from people saying, "How can you get $.60 on that spread when I only see $.15?" Well, CPTI students who have attended my seminars have been bringing in more premium for a long long time. They have learned that you have to read between the lines of the option chain. What do you look for?

Here's a typical SPX option chain: (Example Only)
Mo. Strike Bid Ask Bid Size Ask Size
July 1155 put 4.00 4.80 50 50
July 1160 put 4.90 5.40 10 5
July 1165 put 5.20 6.00 50 5
July 1170 put 6.10 7.30 50 50

Take a look and let's go over what information we have. Remember, before we start any bid/ask negotiation, we need to know what the market maker is looking for -- their invoice price. What do we know?

The 50 contract bid size represents the market maker. The July 1155 put has the market maker on both the bid and the ask. That means that nobody is bidding between the bid and the ask. If they were, it would be represented. So, for the 1155 put, the retail bid/ask spread is .80.

In the 1160 put, there are 10 contracts from someone(s) who want to buy the 1160 put for 4.90. Also, there are 5 contracts from someone who wants to sell the option for 5.40. When there are less that 50 contracts showing, on either the bid or the ask, it should send up a flag. Look deeper and find out how many contracts are waiting.

The 1165 put has the market maker (50) on the bid, but someone (5 contracts) wants to sell the 1165 put for 6.00. We need to estimate what "ask" price the market maker would be posting if nobody was bidding to sell those 5 contracts.

In the 1170 put, once again we see the market maker on both the bid and the ask. This time, however, the "invoice" price is not .80 (as in the 1155 put), it's increased to 1.20. Why? Because the closer the strike price is to where the index is trading, the larger the bid/ask spread.

A Little Common Sense & Deductive Reasoning Go A Long Way
This is far from an exact science. We're going to have to use a little imagination in guess-timating where the market maker wants to be -- especially on options where there are people bidding on both the bid and the ask.

For instance, with the 1165 put, the market maker is on the bid. Since the 1170 put has a bid/ask spread of 1.20, we can approximate the market maker's ask on the 1165 put to be about 6.30 -- thereby putting the market makers "retail" bid/ask to be about 1.10.

The 1160 put is a lot tougher to figure out since there are bids on both the bid and the ask. We can guess that the market maker's "retail" bid/ask spread will be somewhere between the .80 for the 1155 put and the estimated 1.10 for the 1165 put. That would put our guess-timate for the 1160 at about 4.70 bid by 5.70 ask -- a 1.00 bid/ask spread.

So, let's create a hypothetical spread. Let's try to put on an 1165/1155 bull put spread (this is only an example). So, let's look at our revised bid/ask spreads.

Mo. Strike Bid Ask Bid Size Ask Size
July 1155 put 4.00 4.80 50 50
July 1165 put 5.20 6.30 50 50 (market maker est.)

The posted prices for the 1165/1155 bull put spread shows a .40 "natural." Now, the negotiations begin. We can expect to negotiate .20-.30 from the .80 1155 bid/ask spread. We can try to get .40-.50 from the 1165 bid/ask spread. Together, we may be able to get an additional .60 to .80. Add that to our "natural" .40, and we might be able to get 1.00 to 1.20.

Remember, these are just estimates, but they are certainly reasonable. You might put in your order for a credit limit of 1.20 and, if you don't get filled in 15 minutes, reduce it to 1.10. There are no guarantees, but this gives you a place to start. Also, keep in mind that the market moves every minute. The bid/ask spreads will be moving as well. Bid/ask spreads will be widening and narrowing. It's like trying to hit a moving target. I never said it was going to be easy.

Experiment a little. Look at an option chain, get the bid and ask sizes, and see what scenarios you can create. Different indexes seem to have different policies regarding negotiations. If you use negotiations from the SPX to put on RUT trade, lotsa luck!

This whole detective/negotiation is a tough concept to grasp and put to use. At my seminars we spend about two hours going over everything thoroughly, doing numerous examples and creating a wide variety of scenarios. Learning this skill is worth many times the price of the seminar. Just think. If you could get an extra nickel or dime from each option and multiply that by 10 contracts and multiply that times three or four trades a month, you'll end up with a ton of extra premium in your pocket.

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JUNE CPTI POSITIONS
CPTI June Position #2 - SPX Iron Condor - 1198.11
We sold 15 June SPX 1110 puts and bought 15 June SPX 1100 puts for a credit of $.70 ($1,050). Then we sold 15 June SPX 1225 calls and bought 15 June SPX 1235 calls for a credit of about $.70 ($1,050). Our net credit and profit potential is $140 ($2,100). Maximum profit range is 1110 to 1225. Maintenance is $15,000.

CPTI June Position #1 - CME Iron Condor - $247.30
We sold 15 June CME $170 puts and bought 15 June CME $160 puts for a credit of $.60 ($900). Then we sold 15 June CME $230 calls and bought 15 June CME $240 calls for a credit of about $.50 ($750). Our new bull put spread is $185/$175. Our new net credit is now $1.35 ($2,025). New maximum profit range is anywhere below $230. Maintenance is still $15,000. Position closed for $3,225 loss.

CPTI June Position - GOOG Iron Condor - $282.50 (Formerly May Position)
We sold 12 GOOG May 160 puts and bought 12 GOOG May 150 puts. We also sold 12 GOOG May 220 calls and bought 12 GOOG May 230 calls. Our total net credit and profit potential is $1.40 ($1,680). Our maximum profit range is $160 to $220. Maintenance is $12,000.

We bought back the May bear call spread and rolled out to the June $220/$230 bear call spread. We also bought back the May $160 put for a nickel. Our new credit and profit potential is now $2,260.

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ONGOING STRATEGIES
ZERO-PLUS Strategy - July
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.

In May, we placed an SPX Iron Condor with a total net credit was 2,000. It expired worthless. Our new cash position is: $29,500 + $2,000 (May Profit) = $31,500

July Zero Plus Position: Coming Soon

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QQQ ITM Strangle - $37.54
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 May options to June (see details above) and took in a net of $800. Our new total of income generated is $3,850 ($3,050 + $800). We are short the June $37 calls and $36 puts.

We bought back our $36 put for a nickel last week. Now, we're waiting patiently for a pullback to roll it out.

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JULY POSITIONS
CPTI JULY Position #1 - RUT Iron Condor - 626.33
We sold 12 RUT July 580 puts and bought 12 RUT July 570 puts for a credit of $.80 ($960). Then we sold 12 RUT July 670 calls and bought 12 RUT July 680 calls for a credit of $.50 ($600). Our total credit and profit potential is $1.30 ($1,560). The maximum profit range is 580 to 670. Maintenance requirement: $12,000.

This position was suggested on Thursday, June 2 with the RUT trading near 620.

CPTI JULY Position #2 - OEX Iron Condor - 566.30
We soldl 15 July OEX 535 puts and bought 15 July OEX 525 puts for a credit of $.45 ($675). Then we sold 15 July OEX 585 calls and bought 15 July OEX 595 calls for a credit of about $.75 ($1.125). Our total net credit and profit potential is $.95 ($1,420). Maximum profit range of 535 to 585. Maintenance is $15,000.

This position was suggested on Wednesday, June 8 with the OEX trading near 565.

CPTI JULY Position #3 - SPX Bull Put Spread (1/2 of Iron Condor) - 1198.11

We sold 15 July SPX 1125 puts and bought 15 July SPX 1110 puts for a credit of $.60 ($900). Our net credit and profit potential for this bull put spread is $900. Maintenance: $22,500. If we have an opportunity to put on a bear call spread, to complete our Iron Condor, at a safe and profitable level, we will. But, we're not going to force anything or compromise our safety.

This position was suggested on Thursday, June 9 with the SPX near 1193.

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

WE'VE HAD 29 OUT OF 30 PROFITABLE MONTHS!

WANT TO ACHIEVE SUCCESS WITHOUT STRESS? OF COURSE YOU DO!! USE OUR CPTI WEALTH-BUILDING TECHNIQUES!

Spots are filling up fast. There are still some left for my July Philadelphia CPTI 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:
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! The price is right and it will be an experience you'll never forget.

You should really try and make one of these seminars, if you can. With what you learn, you'll see a substantial increase in your trading results. If you've already signed up, I'll see you there. If you haven't signed up, what are you waiting for?

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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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