I think another way to answer Larry’s concern about starting out at max loss is by simply reminding him that the max loss is only achieved if the stock doesn’t rise all the way out to expiry. The theoretical day-by-day value will be a lot different however – if the stock moves even a penny up the moment after you buy it, you should be making a (tniy) profit already!

I think it would be easier to show with a diagram…hockeystick line for expiry payout, and a smoothed parabolic upward sloping curve for theoretical.

My example of buying a long-term put ITM and selling a short-term put ATM against it, while buying a short-term slightly OTM call came to me while I was watching my risk-reward graph on the thinkorswim platform. I realized that I was exposed on the upside and SINCE my intention is to get the stock, the only way to get stock through the trading of options is to either sell puts and be assigned or buy calls and exercise them. In this case, I was covered with my put spread on the downside or if the stock didn’t move; but in the event of a sudden increase, I would have lost big unless I had some calls in place in order to get the stock on the upside.

Again, my intention is to obtain shares and not to synthesize a position through the clever use of options while over-leveraging myself in the process. We are on the same boat.

I am only trying to start lowering my cost basis even before acquiring a single share. Selling near term puts and buying near term calls at the same time is ONLY the synthetic equivalent of long stock if the strikes are the same, which in my case isn’t necessarily true. Let’s look at your Marvel example from this perspective:

Let’s say the stock is at $35.84 on June 22nd 09. The Jan10@40Put is $6.35. 35.84 + 6.35 = 42.19. I have $15,000 for this trade, so I decide that my position should be 300 shares (15000/42.19=355). I could go ahead with this trade and buy 300 shares @ 35.84 and my married put right away. There’s nothing wrong with this. Or like I explained above, I could go ahead and get 3x Jan10@40Put for 6.35 and sell 3x Jul09@35Put for 0.85. I would also buy 3x Jul09@40Call for 0.15. -[6.35 - 0.85 + 0.15 = 5.65] x 300 = -1695 (-11.25 commission) = -1706.25 (debit). I don’t touch the rest of my reserved $15,000 until my shares are acquired.

At July expiration, 7/17, MVL closes at 39.35. So the next Monday, I sell 3x Aug09@40Put for 2.05 and buy 3x Aug09@45C for 0.20 (the $40 calls are too expensive so i take a risk and choose the $45). I receive [2.05 - 0.20 = 1.85] x 300 = 555 (-7.5 comm) = 547.50 (credit)

At August expiration, 8/21, MVL closes at $38.45. My short puts are ITM. I could let them be put to me, which I most likely would have done in real life. But for the sake of demonstration and argument, let’s say that I rolled them out to September:

I buy back 3x Aug09@40Put for 1.55 and sell 3x Sep09@40Put for 2.10. I also chose to buy 3x Sep09@40Call for 0.45. For the first time I have synthetic stock.
[-1.55 + 2.10 - 0.45 = 0.10] x 300 = 30 (-11.25 comm) = 18.75 (cr).

At September expiration, 9/18, MVL shot up to $49.95. I can choose to exercise my calls or just close out all my positions because I don’t see any more upside to MVL since the deal with DIS is pretty much guaranteed. So, let’s close out everything:

I sell my Sep09@40C which are now worth 10.00 and sell my long-term put acquired back in June for 0.25. I receive: 10.25 x 300 = 3075 (-7.5) = 3067.5 (cr).

To recap: I shelled out 1706.25 on 6/22. I received 547.50 + 18.75 + 3067.5 = 3633.75.
3633.75 – 1706.25 = 1927.5 net profit (a 12.85% gain on the entire $15000 put aside)

Had I just bought 300 shares + put on 6/22 => -42.19 x 300 = -12657 (-8.75 comm) = 12666.75;
and had I sold them on 8/21 for 49.95 + 0.25 = 50.20 x 300 = 15060 (-8.75 comm) = 15051.25, I’d be up 2384.5.

In this context, buying the shares on 6/22 would have yielded a better result on the entire amount set aside; however MVL’s behavior during the same period was also highly unusual with the takeover and the spectacular price increase. If the stock hadn’t shot up so suddenly, I am pretty sure that my method would have outperformed acquiring shares right away.

My point was that I never said that I was over-leveraging myself with options and that the method described above limits losses as well as lets you participate to the increase in price until shares are put to you or calls are exercised; while at the same time reducing your cost basis.

Frederic

Sorry that you object to the price of The Blueprint. I have a very impressive satisfaction record, though, from experienced options traders. Many have called or written that they have traded options for years… more than one on the Chicago floor… and said that The Blueprint has changed their outlook on options trading and position sizing for life.

Doesn’t get much better than that.

To address your point about selling puts to acquire stock… uh, it IS in the book. The reason you never have seen me write about it is that I have reserved that and countless other details FOR the book. But since you bring it up and it’s no great secret, yes, you can sell puts against puts with the intent to have stock assigned to you.

My friend Ernie Zerenner (founder of PowerOptions… http://www.poweropt.com/rat if you would like two free weeks of the best options searches for 23 strategies) was selling puts naked, with the intent of getting assigned. He would THEN pick up a long put to protect the shares.

I pointed out that this would expose him to risk at least for a time, and then gave him the entry technique you described. “You could buy puts far out in time and sell near term puts with the intent of getting assigned. The net result of this would be that IF you get assigned, you will have an RPM (RadioActive Profit Machine) in place with long stock for which you received a premium up front, plus a long term put for protection.

However..! As I pointed out to Ernie, and now am pointing out to you: This entry technique is NOT a limited risk, unlimited upside play… it is a time spread with the POTENTIAL for turning into a protected trade with unlimited upside.

Take MVL for example. I bought Jan 2010 $40 put to protect my MVL stock on June 22. On August 31, Disney (DIS) announced its intent to buy MVL for $4.4 billion.

My shares went from the mid-thirties to almost fifty overnight. My Jan 2010 $40 put went from $6.50 to .30. But that’s okay… because I OWNED the STOCK at a cost basis of $31.71, plus did Income Methods to reduce even that cost.

I made thousands on MVL. But if I had bought a $40 put option and sold near term $40s or $45s against with the intent of being assigned… Well, I would be able to keep the near term premium on those puts, yes. But I’d have been KILLED by MVL’s sudden updraft on the long puts.

Nothing wrong with your time spread idea, so long as you’re right. ON the other hand, rather than managing one option against the other, I was just long stock.

NOW… I did read your example of buying calls as well as selling near term puts. Wow, NOW we’re getting fancy!

Selling near term puts and buying near term calls at the same time is the synthetic equivalent as buying stock. My point is, why not just buy the stock? This FORCES me to have an optimum position size in my married put position, whereas using the synthetic equivalents does not.

You can check out my other writings on that elsewhere. But it’s just common sense: the Black-Scholes equation ASSUMES that you have the capital to trade long stock but DON’T… you buy a call with a little of that capital and deposit the rest in an interest bearing account instead. That’s parity.

If we simply buy a call, or sell a put and buy a call, we are leveraging ourselves. When use we leverage, we can do a lot more than without… we can reap a lot of profits OR we can get into a lot more trouble!

Best wishes to you, Frederic. I’m sure you are savvy enough to figure out at least a few of my so-called Income Methods. I’ll just caution you to watch your position sizing, especially with the panic buying that seems to be brewing now.

Happy Trading,

Kurt

Larry:

No, Larry, the bailing out water analogy doesn’t work. Let me give you another, similar analogy… that ALSO doesn’t work… that of driving a car off the parking lot at a car dealership. It immediately loses 20% of its value.

WRONG! (not the car, but the stock plus put)

Most folks are under the misconception that buying a stock and a put together causes a sudden loss in value like what you’re describing. It doesn’t.

Here’s a real-life example: You like a stock that’s trading at, say, $36.38 X $36.40, and at the same time a Oct 2010 $40 put trading at $5.40 X $5.60. That’s the price on Big Lots (BIG), which I happen to be long on.

To make this BIG purchase, right now, you’ll pay $36.40 for the stock and $5.60 for the put (unless you put in a limit order and get filled “in the spread” for an even better price. That’s $42 for an investment GUARANTEED to be worth $40 all the way to October 2010.

The next INSTANT, say you decide that you just made a mistake. This stock looks good but another looks a whole lot better. Plus that Kurt guy is ugly and his mother dresses him funny… why oh why did I try and copy his BIG trade?

So you sell off your BIG position. Hmm… you don’t lose the $2 AT RISK amount you originally signed up for. No, if BIG is trading at $36.38 X $36.40 as I said… you get $36.38 for it. Lost two cents. If Oct 2010 $40 puts are trading at $5.40 X $5.60, you get $5.40. Lost twenty cents there, LESS if you got filled “in the spread” as I mentioned before.

That’s .22 cents loss, NOT the $2.00 that you and so many others believe that you start out “under water”.

So in your example with the swimming pool, and with others that talk about the car dealership, it doesn’t fly. The only reason I might have the full loss of $2 immediately after the purchase like that is a news event that takes the stock down HARD… in which case I’ll be REALLY glad that I bought the put. Otherwise I’m fully exposed to the stock’s crash, instead of protected at that $2 AT RISK level.

Got it? Now, as time goes by and the stock fluctuates up, down, or goes sideways there will be a gradual approach to that $2 maximum loss… but that $2 loss if offset by a move of about five percent in the stock. THAT I can believe.

So if the stock goes up, the net value of the put plus stock goes up. If the stock goes down, my maximum AT RISK amount is already locked in. I can elect to do one or more “Income Methods”… TEN different ways that I’ve developed for adjusting the original married put position… to change the picture and reduce risk, take income, or BOTH… while staying protected much, much better than any stop order could possibly do for me.

Ahh… it’s so refreshing to have an unlimited upside while having no worries about sudden reversals. The peace of mind is WORTH the amount I “put” into the protection.

I could have accomplished the same result by putting my entire porfolio in SPY in July 2007 and taking a 3 year nap. oh well, live and learn. Now I am ready to pull ahead of my July 2007 peak portfolio value using better techniques and discipline.

Brian

I am now using a strategy I have developed that is fairly conservative yet productive, I think, but maybe not optimal. I have sold out of all my stock positions and replaced with Call Spreads on my favorite stocks. Most are fairly large cap because small caps do not trade well in the options markets. I buy well into the money by about 20-25% (ITM for short) which eliminates almost all the time premium for 3-4 months out options. I then sell an OTM call in the same month with about a 5-7% premium, usually 2-3 strikes above the current price.

This gives me a situation where my risk is defined (cost of the option less the call premium). Although my upside oppty is limited, it is levered by the long call option. So, if the sold call strike is 10% above the current price, I have the potential to make 40-50% return if held to expiration. This should be a good return if repeated 2-3 times per year. But I also have developed a discipline to close the trade once the current price hits the strike (or gets close). After this point, the sold call losses offset most of the long call gains.

If I close out, I can also just roll the spread up and out on the calendar if I continue to like the story. To limit my risk further, i only employ this strategy with up to 40% of my total portfolio and I have started buying a large SP500 index put position that covers 40% of my total exposure (including the levered amount of the options, net of the short calls).

But now after attending your seminar I am thinking I should mix in some of the married puts, but married to long ITM calls instead of stock. What do you think?

I have not read your blueprint because I object to its price and I’m not a newbie either and so I can figure out a few of your so-called income methods.

I don’t know if you’ve ever touched on the subject but I’ve never seen you talk or write about acquiring stocks with selling puts. For example, instead of purchasing 1000 shares of stocks and buying 10 long term ITM puts, I would advocate buying the protective puts right away but at the same time selling 10 cash-secured put for the nearest expiration month right at the money. The time value is at its highest and this way, the amount at risk on the downside is even less than if you had bought the stock right away. The following month depending where the stock is at exp, you might be able to roll down and out for a credit or be assigned if the price went down, roll out at the same strike for a credit if the stock stayed even and this way you continue eating away at your amount at risk; or you let you put expired worthless if the stock went up and you roll up and out for another credit. With this setup, the most at risk is if the stock really goes up violently because you can participate to the upside; the way to remedy this is to purchase the same amount of OTM calls as you sell ATM puts. They both expire in the same month and if the price goes up, then your calls gain in value and you fully participate to the upside. You may then choose to exercise your calls and then continue to extract income from them with your different income methods.

Another thing that i’ve learned is that there’s no rule that stipulates that you should sell as many calls as every 100 shares of stock that you own. Selling a call for every 300-400 shares is better because it brings some income and leaves the upside open to roll out and up if necessary.

Frederic

For me that’s about seven or eight different stocks, each of which I’ve “legged” into. I may not “put” all of my RPMs (RadioActive Profit Machines) into operation at the same time.

Now, one layer of protection is the put option. Another layer is that depending on my level of aggression, I will only expose .5% – 2% of my account in any one stock.

Say you only want to expose 1% of your account in each position. You find a $50ish stock with 5% AT RISK in that particular trade. The DOLLAR amount for risking 5% in a $50 trade is $2.50, or $250 per hundred shares, right? Since your account is $200K you would take a position with 800 shares.

800 X $2.50 = $2,000 which is 1% of your total $200K to trade. Ta-da…

Now you only have $2,000 AT RISK in that particular trade, right? Right. But it takes about $40K of your capital to assemble that RPM so you have $160K left.

One of the coolest things about trading RadioActively is that your position sizing gets figured out FOR you. In this same account you might have 100 shares of GOOG, 400 shares of GMCR, 3500 shares of GE but be risking the same dollar amount with each.

Harvey, I think you’re off to a great start. 80% of all traders don’t even give this stuff (position sizing and asset allocation) a thought… they just start putting on trades and hoping for the best. You, on the other hand, are looking to diversify and give yourself the best chance of success. I expect to be hearing more from you soon, and more success stories than war stories!

Happy Trading,

Kurt

I’m sure I speak for many others (maybe not your competitors) when I say “I appreciate the effort you’ve put in to The Blueprint and other works that you’ve done and continue to do.”

There’s something that bugs me though;

While setting up a stock and put position in the way you describe absolutely limits the downside to a known amount from the outset, doesn’t it also put you in the situation whereby you’re sitting at that guaranteed max loss from day 1?

What I mean is, although there’s an almost impenetrable floor on the downside, your position starts from the floor and you have to hope or work it back up to breakeven before you can then start to hope for a return?

How’s this for an analogy; Imagine a swimming pool. The level of the water is the stock price, gently rippling away, up and down. You could buy the stock and you would become a little boat bobbing up and down on the water, if someone starts the wave machine you could ride a big wave up, if you hit it wrong you could take on water and need to bail, at this point the swimming pool has no bottom. You buy a put which in this example would be a rope that tied your boat to the side of the pool, it has a certain length so you know if you get in trouble you will only go down so far, regardless of how deep the water is, the price for this safety rope is that you take on some water so your boat sits lower in the water. The rope will only be there for a certain time. Can you bail out the water before the rope disappears? Will you be able to ride a big wave before the rope disappears and take your boat out at the crest?

This isn’t necessarily all bad, accounts could survive a lot longer if they used this method, but I think people should also be aware of the importance of being able to evaluate a stock to pick prior to entering into a stock+put set-up. I don’t think just because a RPM with single digit risk is found using the Power Option tools that it’s necessarily a good move. Could evaluating a stock and chart analysis also form parts of a future Blueprint?

Larry