Option Investor


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The market is lulling us into a false sense of security. The last three or four sessions have not had the outrageous volatility that we suffered through the past few weeks. But that doesn't mean we're out of the woods. Many technical types still believe we're going to test the lows again before we can be comfortable with the fact that we put in a bottom. I'm not ready to risk my bottom on this bottom quite yet.

September, as you probably know by now, is a five week option cycle - lots of time for almost anything to happen. Our positions look relatively safe for now, but they looked the same way last month and we saw what happened.

I said last week that we're going to devote some column space to going over some of the basic strategies we use here in my Couch Potato Trader column. Recognizing that our current primary strategy is the Iron Condor, let's take a look at its components. Most of you already know most of these concepts. You better if you're trading our strategies. If not, you're in deep s**t and way out of your depth.

I suggest that newer traders, who want to get up to speed before they start putting their hard-earned dollars at risk, read these instructional columns carefully and print them out for reference purposes.

A Bull Put Spread is not a mystery. The words "bull" and "put" and "spread" tell the story. It is a "bullish" position. The word "put" means that puts (not calls) are used and the word "spread" means that more than one option is being used.

The Bull Put Spread is a "vertical" spread and one of the two basic components of the Iron Condor. A "vertical spread" simply means that the two options comprising the spread are both puts and they have the same expiration month.

The Bull Put Spread consists of the sale of one put option and the purchase of an option at a lower strike price. The put option that is sold will bring in more money than the put option that is purchased - resulting in a net credit. It is thereby considered a "credit" spread. The net credit shows up in our account the very same business day.

There is a maintenance requirement on credit spreads. Your brokerage firm will hold, in your account, the difference between the strike prices multiplied by the number of contracts you're trading. For instance, if you sell the $45 put and buy the $40 put, the broker would hold $500 ($5.00 x 100 shares) per contract. A 10 contract position would require $5,000 of maintenance. The numbers, in the example below, do not include the expense of commissions.

For example: You have a short term bullish feeling about XYZ Company that is trading at $50.00 with about four weeks remaining to expiration. You believe that, during this option cycle, XYZ is going to remain at $50 or possibly move up in value. Below is an abbreviated option chain of the available options.

Strike Price Bid Ask
Sept. $40 put .10 .15
Sept. $42.50 put .25 .30
Sept. $45 put .50 .60
Sept. $47.50 put 1.05 1.15
Sept. $50 put 1.95 2.05

Based on the above chain, let's explore a typical trade. Remember, we're bullish. So, let's:

Sell 10 contracts of XYZ Sept. 47.50 put @ $1.05 ($1,050)
Buy 10 contracts of XYZ Sept. 45.00 put @ $.60 ($600)
Net credit of $450 ($1,050 - $600)
Maintenance = $2,500 ($2.50 difference between strikes x 10 contracts)

We have chosen to sell the $47.50 put for a very good reason. It's $2.50 below $50 (where XYZ is currently trading). That means that XYZ can actually go down $2.50 and we will still be 100% profitable. As much as stocks move around in a high volatility environment, that cushion is nice to have.

What is your break even number? XYZ can close as low as $46.90 ($47.50 - $.60) before you start losing money.

Even though it's possible to place this trade by first buying the $45 put and then selling the $47.50 put, it's much better to enter the trade as a single transaction with a net credit. The problem with trading the options separately is that the market is constantly moving. If you were to buy the $45 put for $.60, it's very possible the market will move away in the time that it takes to learn about your fill and to send in the second order.

Most good brokerage firms will have screens that allow you to input the specifics of both options and request a net credit. It's easier, cleaner and your chance of getting filled is greatly improved.

Now, let's assume that you were right. At expiration, XYZ is somewhere above $47.50. We calculate the potential profit by dividing the profit ($450) by the amount of out of pocket risk ($2,050). The out of pocket risk is the amount being held as maintenance ($2,500) less the amount of premium taken in when the position was initiated ($450).

$600 divided by $2,050 = 21.9% return on your risk. Not too shabby. But, that's if you were right. The object of the trade is for both options to expire worthless. That means you can keep the entire $450 of premium you brought in when you established the position.

What if you're wrong? You are exposed for $2,050. You're risk is defined and you'll never lose more than the $2,050. But, perhaps your analysis of the trade suggests that you should exit your position if XYZ trades down to $48. You should check the charts to find realistic support and resistance levels before placing the trade. That will give you a bit of guidance and enable you to choose an exit point where you will close the position and minimize your loss.

When you put on a bull put spread, you are not obligated to hold the position through option expiration. You can close it at any time.

You would exit the trade the same way you enter it - trading both options in a single transaction for a net debit.

If, at some point during the option cycle, XYZ moves far enough away from your bull put spread, you might be able to close the position and lock in a large percentage of the profit. If, with a week to go, XYZ is trading at $62, the $47.50 put may only cost you a nickel to buy it back. As soon as you buy it back, you are no longer exposed and your maintenance dollars (being held by the broker) are released back to you.

It doesn't make sense to be exposed to a possible catastrophic event for that last week for a nickel. If you held on, you would be risking the other $.55 of premium to make that last nickel. It doesn't make sense. Take the money and run.

When we trade our Iron Condors, we put on bull put spreads on indexes rather than stocks - and we try to put them on very far away OTM (out of the money). We use indexes because they are more diversified than individual stocks. If a single stock has a problem, there are hundreds of other stocks to soften the blow. An index is not as vulnerable as an individual stock.

Our objective, when trading the indexes, is to create as large a cushion as possible. Although the bull put spread is a bullish position, we want to give ourselves a lot of room to be wrong if the market is not bullish.

Next, we'll look at the bear call spread - the evil twin of the bull put spread. The bear call spread is the other component of the Iron Condor. Stay tuned to this station . . .

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Charlotte (Sept. 22nd & 23rd)

Don't wait to make your reservation. The seats go quickly.

There are two "retake" spots remaining for the Charlotte seminar. These retake spots are free for those who have paid to attend one of my previous seminars and who want to retake the seminar a second time. They're reserved on a first come first serve basis.

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CPTI September Position #1 - RUT - Bull Put Spread - 788.25

On 7/24, with the RUT at 822.70, we sold 20 September RUT 700 puts and bought 20 September RUT 690 puts for a credit of $.70 ($1,400). Total net credit and profit potential (so far) of about $.70 ($1.40). Our maintenance is $20,000. We'll look for opportunities to complete our Iron Condor if/when the market pops up.

CPTI September Position #2 - SPX - Bull Put Spread - 1462.50
On 8/3, with the SPX at about 1463, we sold 20 September SPX 1260 puts and bought 20 September 1250 puts for a credit of $.50 ($1,000). Our maintenance is $20,000. We'll look for opportunities to complete the Iron Condor if/when the market bounces.

CPTI September Position #3 - RUT - Iron Condor - 788.25
(Formerly August Position) On 6/29, with the RUT at 844, we sold 20 August RUT 740 puts and then bought 20 August RUT 730 puts for a credit of $.45 ($900). Total net credit and profit potential of about $.45 ($900).

Adjustment: On 7/26, we closed the original 20-contract bull put spread position and established a 30-contract Iron Condor consisting of the 670/660 bull put spread and the 840/850 bear call spread. Maintenance is now $30,000 and the new maximum profit range is 670 to 840. The profit potential of $900 remains the same.

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In the past, I outlined a strategy based on an initial investment of $100,000. At that time, $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. We are not compounding our profits by dramatically increasing the number of contracts we trade. With the July profits, our new cash total is $55,060 ($52,210 $2,850).


RUT - June Iron Condor - 100% PROFITABLE

On 6/21, with the RUT at 839.81, we sold 30 July RUT 770 puts and then bought 20 July RUT 760 puts for a credit of $.55 ($1,650). Then we sold 30 July RUT 900 calls and bought 30 July RUT 910 calls for a credit of about $.40 ($1,200). Total net credit and profit potential of about $.95 ($2,850). We were 100% profitable and pocketed $2,850.

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Take your trading from a "hobby" to a profitable "business." You need the information you'll learn at my CPTI seminar. You'll learn more than the "how to's" of trading our strategies. You'll learn a new lifestyle - one that can last a lifetime.

It's always a challenge (and a pleasure) for me to have a roomful of bright people who have a passion for, and are excited about, learning. We go over everything imaginable - from the non-directional strategies to the psychology of trading. We cover a lot more than the mechanics. Inquiring minds want to know the whens and the whys -- not just the hows. That way, they're prepared for the best (and the worst) - and know the best way to handle either situation. Contact me and I'll personally call you with all the details.

If you're a SERIOUS options trader, you want to learn the nuances of our advanced non-directional trading strategies and hone your trading skills. Contact me ASAP at mparnos@optioninvestor.com. Send me your phone number. I'll personally call you with all the pertinent information. The price is a bargain - ONLY $995.00 -- less than the profit from one Iron Condor trade. Take advantage of the "early bird special" and save $100. You'll have a two-day experience that you'll remember, and profit from, for a lifetime. I limit my CPTI seminars to ONLY 25 ATTENDEES. And, as a bonus, if you attend one of my CPTI seminars, you are entitled to RETAKE the seminar a SECOND TIME at NO CHARGE!


You should definitely attend one of my seminars. With what you learn, you'll see a substantial increase in your trading results. Contact me at: mparnos@optioninvestor.com. 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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Remember the CPTI credo: Our remote batteries and self-discipline should 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 Trader 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 (though many often do) 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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