I thought it would be a good idea to go through the thought process of exploring a new trade possibility, analyzing it, and then executing a trade. What you're about to read is real. It's not hypothetical, nor are you in the Twilight Zone.
On March 28th, the RUT was trading near 690 - not real low and not real high. I got an email from David, a seminar grad. He told me of a trade he put on and wanted to know my opinion. Very interesting.
The day before, David went all the way out to the December 2008 cycle and sold two contracts of the Russell 200 (RUT) 450 puts for a credit of about $7.20, taking in $1,460. I thought about it. What could the downside be? First, he did the position uncovered. Second, he would be exposed to the markets for nine months - the same as being pregnant.
How much maintenance is required on such a ballsy trade? Well, David has taken advantage of the customer portfolio margining maintenance program offered by his broker, BrokersXpress. Using customer portfolio margining resulted in his broker holding only about $3,000 in initial maintenance. Notice that I said "initial." With portfolio margining, the amount of maintenance held will fluctuate depending on the up and down moves in the market. When you are short a put, the maintenance will increase if the index moves down. Conversely, the maintenance will go down if the index moves up - further out of the money.
Unfortunately, not everyone will qualify for the customer portfolio margining. Only a few brokerage firms currently offer it. If you're interested in more info on who offers the customer portfolio margining, send me your phone number. I'll call you to discuss it. You can still do this strategy without the customer portfolio margining, but the maintenance requirement would be substantially higher.
Also, not all of you will have the trading approval level to trade uncovered options. That is something you will have to resolve with your broker. It's typically based on your trading experience and, to a degree, your account size.
Now, here are the good points of this strategy. First, $7.20 is a nice chunk of premium. If you divide the $7.20 by the nine months of exposure, you get $.80 per month. When is the last time we got $.80 on a monthly RUT bull put spread? Like never.
How about the sleep-ability factor? Sounds silly, but it's important. With a 240-point cushion, I think I could sleep pretty well. I checked the delta. It was -1. That means there is a 99% probability for success.
If everything works out, and the short RUT 450 puts expire worthless, that's a very nice return on the initial maintenance level - about 50% for nine months. In the market, a 50% return is something most traders would kill for - annually. And this was for only nine months.
I decided to give it a try. By the time I made my decision, the RUT had moved down to the 690 area and the RUT 450 put had increased a little in value. I was able to sell four puts for $8.00, taking in about $3,200. This translates into an average of just under $.90 per month.
I'm a pretty patient guy. However, I don't know how long I'll be able to keep my hands off the trade. Right now, with the RUT at 713, I could likely buy back the short 450 options for $6.00. That would result in an $800 profit, for less than a week. ($8.00 - $6.00 = $2.00 x 4 contracts). Hopefully, I'll have the discipline to hang on for awhile. I won't need the maintenance dollars for anything else, so I don't have that motivation to close the position. As many of you know, I have a tendency to lock in smaller profits and wait for the next opportunity. With this strategy, I don't think the profit would be jeopardized by being patient. We'll see.
Now, even though there is, now, a 263-point cushion, there are those will still worry about the end of the world. In spite of the 99% probability, there are those personalities that will dwell on the 1%. It's possible to buy a bit of insurance along the way - just in case.
I'm thinking out loud as I write this. Looking at tonight's option chain, the May 500 RUT puts could be bought for $.25 ($250 per contract) or less. That would provide protection for at least two option cycles. Then, as time goes on, you could buy other options to protect subsequent cycles. The price may vary - up or down, depending on where the RUT is trading. Considering how much premium was taken in initially, a portion of it can easily be budgeted for far OTM protective puts still leaving plenty of profit.
Getting back to David. Here's a seminar grad who took what he learned at the two-day advanced seminar and got creative. He didn't reinvent the wheel, but he has discovered a variation that fits nicely something that we can do. With the help and guidance of our broker, Mike Cavanaugh, as they say on American Idol, David made the song his own. Good job.
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CPTI APRIL POSITIONS
On 3/5, with the RUT at about 674.50, we sold 20 RUT April 560 puts and bought 20 RUT April 550 puts for a credit of $.55 ($1,100). Maintenance is $20,000. We will look to put on a bear call spread in the future - IF it makes sense.
CPTI April Position #2 - SPX Bull Put Spread - 1369.31
On 3/10, with the SPX at about 1288, we sold 20 SPX April 1110 puts and bought 20 SPX April 1100 puts for a credit of $.55 ($1,100). Maintenance is $20,000. We will look to put on a bear call spread in the future - IF it makes sense.
CPTI MAY POSITION
CPTI May Position #1 - SPX Bull Put Spread - 1369.31
On 3/31, with the SPX at about 1316, we sold 20 SPX May 1130 puts and bought 20 SPX May 1120 puts for a credit of $.55 ($1,100). Maintenance is $20,000. We will look to put on a bear call spread in the future - IF it makes sense.
ONGOING STRATEGY - THE ZERO-PLUS Strategy
ZERO PLUS POSITION - SPX - Bull Put Spread
On 3/31, with the SPX at 1316, we sold 30 SPX May 1130 puts and bought 30 SPX May 1120 puts for a credit of $.55 ($1,650). Maintenance is $30,000. We have plenty of time to find a bear call spread. Let's hope the market cooperates.
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