Anatomy of a RadioActive Profit Machine, Part III: BULLETPROOFING HUM

Greetings, Traders!

Here’s the latest installment of Anatomy of a RadioActive Profit Machine, in which I walk the savvy Trader (that’s you!) through the steps that I took, showing how  to make 200 shares of Humana Resources stock BULLETPROOF… meaning that you can benefit from HUM rising but cannot lose any capital if HUM falls.

Kinda cool. Especially since it’s still rising.

In order to do today’s lesson and learn how HUM became BULLETPROOF… we gotta go back a few articles and show the setup again, as well as the Income Method #6 play from last week.

After that, I’ll show another two totally riskless spread trades that made HUM so that it can’t lose, even with a market reversal or catastrophic news event.

SO… ready to see how that works? Read on, Trader!

In the first installment we saw the RadioActive Profit Machine initial setup, a unique kind of Married Put trade with an in-the-money put option and a far-out expiration:

March 11. 2011 Humana RPM (RadioActive Profit Machine)
1) HUM  shares                $63.90
2) Aug 2011 $65 put       +$ 5.80
3) Total Invested               $69.70
4) Guaranteed Exit          -$65.00
5) Total Amount AT RISK  $ 4.70
…or 6.7%

This unique setup makes for a guaranteed exit (line 4 above) of $65 regardless of where HUM actually ends up on the third Friday in August, 2011. This gives me a maximum loss of $4.70… if and ONLY if three conditions are present:

1) the stock actually does in fact go below $65 per share
2) I make no adjustments
3) I hold the position all the way to expiration

So while the above position does have a maximum AT RISK of $4.70 or 6.7% of my capital invested, it is very unlikely that I will suffer that entire loss… because two of the above three factors are within my control 😉

Here’s the graph of how she started out:

Click on the image to enlarge it and see greater detail.

You’ll note that it says, “$940 Max Risk” but this is because I used the above setup “times two”… that is, instead of getting 100 shares and one put it was 200 shares and two puts.

There’s still only 6.7% of the capital being used for the trade AT RISK. RadioActive Trading is scalable depending on how much capital you have.

That was the first post, now for a review of last week’s installment: When we last saw our hero, he had taken the market maker’s edge and put it on his side by using a ‘nested spread’. The RadioActive Trading Income Methods are ‘nested spread’ trades done within the context of a married put to reduce the cost basis, reduce risk, take income, OR..! All three.

The particular “Income Method” or ‘nested spread trade’ we saw last week was Income Method #6, Selling a Bear Call Spread.

Two .50 cent Bear Call Spreads could make $100, but risks $400

Remember that the Humana Resources RPM is insured clear out to August 2011.

However, ‘nested’ within that Married Put position is a second trade, an April $67.50/$70 Bear Call Spread.

I’d sold two April $67.50 calls for .95 cents, then used some of the proceeds to buy two April $70 calls at .45 cents. That’s .50 cents credit per spread, or $100 IN.

Click on the image to see the details more clearly. If HUM stays below $67.50, this play collects $100 for the Trader and reduces the cost basis of the MAIN trade… the Married Put position… by the same amount.

However, if the spread goes against, it could end up costing the Trader $400 bucks! …or could it?

The SECRET of ‘nested spreads’… the RadioActive Trading Income Methods… is that putting them on properly introduces no risk. Done correctly, Income Method #6 is a Bear Call Spread that collects a credit. But because of the fact that we already own stock, it cannot lose.

Come again?

Yes, the claim that the spread introduces no risk but takes a credit is a tall order, you betcha. But it’s true. Read further…

The ONLY way that the Bear Call Spread can end up hurting us is if the stock goes up… and! Don’t forget: we already own it. The graph shows what the combined positions look like.

The original AT RISK amount of the Married Put had been $940, and the AT RISK amount of the Bear Call Spread by itself was $400. But combining the two trades… NESTING one within another… eliminated some risk from both sides. $940 risk + $400 risk = $840 risk?

Yup.

And the BEST part about this is that the net position still has an unlimited upside… there is no cap to the possible gain. Heads you win, tails you don’t lose much!

Okay Trader, now you’re caught up to speed. Let’s go a bit further, shall we? What about going to heads you win, tails you win MORE… 😎

What we talked about showing you today was BULLETPROOFING… taking a position that has unlimited upside potential, then making it so that it cannot lose, even if something catastrophic happens to the stock.

Introducing a different ‘nested spread trade’. This one is called RadioActive Trading Income Method #4. If I were to sell August $65 puts and buy August $70 puts, we would (normally) call that configuration a Bear Put Spread. Here’s the graph:

Risk Cut in Half by Swapping Puts

HUM Married Put after Income Method 6 and 4

 

What you’ll notice is that we still have a RISKLESS Bear Call Spread represented by the blue line never quite dipping into negative territory.

Even if HUM goes to $70 exactly, the net position is not in trouble. If it goes higher, we’re making money. And the worst possible thing happening… the stock going to ONE PENNY… could only at this point end up costing the player 2.8%.

Shoot, let’s take even THAT risk away, shall we? 😉

As HUM went up past $70 a share, there was yet another Income Method #4 opportunity:

Buy to Open $75 puts                  $7.15
Sell to Close $70 Puts               – $4.35
Net DEBIT of “Income Method” 4:  $2.80

Remember I’m spending this $2.80 to raise the guaranteed payout of my married put by $5.00.

HUM is BULLETPROOF... can win, CAN'T LOSE

Here’s the net result, graphically: