Taking Credit Where It’s Due ;-)

Greetings, Traders!

So, we’ve been talking about ‘Bulletproofing’, a phenomenon that can happen when you own a Married Put… shares of stock plus an insurance policy called a put option. We’ve also be talking about what I call “Income Methods” or ‘Nested Spread Trades” to reduce the cost basis, capture income, reduce risk, or all three.

Once your net cost basis for both the stock and the put is LOWER than the strike price of the put you are “Bulletproof”: You own a stock that has unlimited potential for growth but can no longer lose you any of your starting capital.

In the Blog post series entitled, “Anatomy of a RadioActive Profit Machine“, I’ve shown you how you might take a stock and put option that are purchased together into this blessed “Bulletproof” state.

TODAY, I’m going to show a couple ideas on how to “Bulletproof” a stock you own that’s already up… locking in earned profits WITHOUT necessarily selling… and keep the upside open for continued growth.

In one trade described below, I made 30+% without having a dime AT RISK. In another trade below, I was able to advise a client so that he is GUARANTEED to take out at least 120%, but that’s the worst case scenario. Last I heard, he’s still in the trade and may make more. Interested? Skeptical? Read on:

Again, “Bulletproof” means you have stock and a put option that protects its value, and the net cost basis is less than the strike price of the put. Once “Bulletproof”, your position has unlimited upside potential, yes… but what if you want to get paid for your time while you are holding? Enter another use for “Nested Spread Trades”!

“In today’s post I’ll include two examples of real trades that I’ve done or that RadioActive Trading clients have done. I’m using classic examples because at the time I crafted them, I created videos that you may link to and watch right after the descriptions. The HUM trade is still in progress at the time of this writing.”

Nested Spread Trades Can Take a Credit Without Introducing RISK

First up: MARVEL. Yes, the company that up until August of 2009 managed the universe of superheroes (and villains!) created by comic book genius Stan Lee.

To skip the next few lines of text and see the whole thing explained in five minutes, click A MARVEL-ous Trade.

In June of 2009 I was sitting on 100 shares of stock after a larger, successful play. I had sold off most of my MVL stock, but after getting assigned on a covered call I had 100 shares left over. What to do with them?

Those shares had been purchased at a non-adjusted cost basis of $31.71. On June 22, 2009 MVL was trading at $35.98. I knew that I COULD sell those shares for an immediate $427 profit ($3598 minus $3171, not counting commissions) but decided to ‘Bulletproof’ them instead. Here’s how that looked:

100 shares of MVL stock at    $31.71
1 Jan 2010 $40 put option at +$ 6.50
Total Cost of Position             $38.21
Put guarantees my exit at      -$40.00
Total Amount AT RISK           -$  1.79

Now, that AT RISK number above being negative means that I have zero risk… that is, I am guaranteed not to lose any of the capital in this trade.

No break even line. Combined cost basis is lower than the strike price.

Now, I know what you may be thinking: “Kurt, you just had $427 in profit on the stock alone, if only you just sold it. Now, you’ve swapped that for $179. How is THAT a good trade?”

Well, the answer is that I haven’t swapped $427 for $179 at all. If I changed my mind a second later all that would be lost would be the .10 or .20 cent difference in the bid-ask spread for the put.

I HAVE swapped the situation of having cash-in-hand and no further opportunity… for a position that has unlimited upside potential but that can’t lose me any of my original invested capital at all.

IN other words, I’m almost guaranteed to take out MORE than that bottom line of $179. Oh, and for my return to be that small, three things must happen:

1) MVL has to go down,
2) I have to hold all the way (SIX whole months!) til Jan 2010 expiration, and
3) I must make no adjustments (‘Nested Spreads’)

Of those three conditions, I am in total control of two. I’m NOT going to hold til expiration, and I AM going to use a ‘Nested Spread’ to pull out premium from this trade.

So here’s the story: ‘Nested’ within the Married Put position, I sold to open an August $40 call for $1.78, simultaneously buying to open an August $45 call for .28 cents. Net credit: $1.50 per spread, or $150 dollars.

Normally a Bear Call Spread has RISK

Normally, performing this spread would be risky and totally dependent on what the stock did next. I might keep my $150 so long as MVL stayed below $40 a share. If MVL went to $41.50 on expiration Friday, I would have to pay back the $1.50 credit to keep my stock. Oh, and if MVL went to $45, $46, $47… I would have to pay back $5.00 to satisfy the spread. That, less the credit of $1.50 makes for a $350 LOSS.

That is, as I said… “Normally.”

In the case of ‘Nesting’ this trade within the Married Put, however, the Bear Call Spread has introduced NO risk. Check the chart… instead of a negative -$1.79 AT RISK (negative risk means a guaranteed minimum gain), I have altered the position to a negative -$3.29 AT RISK.

Unlimited upside, premium captured. No added risk!

If MVL goes higher than $45, I may make even more. That’s because I can deliver the shares at $40 but I have them AND the put option at a total cost basis of less than that, $38.21. So with that $1.79 difference in pocket already, look what else comes up..! The long $45 call… that I’ve been PAID to own… takes over and grows in value as MVL continues her upward march.

Oh, PLUS that long put will still be worth SOMEthing. Even though it has lost value it won’t be down to zero in August… not if it doesn’t expire til January. 😉

Point is, what I have done is to swap my gain in the stock (a guaranteed $4.27 profit) for a position that STILL has a guaranteed $3.29 gain… but unlimited upside potential.

Want the rest of THIS story? Heh… glad you asked. Converting MVL to a RadioActive Trading style Married Put ended up putting just over 30% on the $3821 capital invested into my account without ever risking a dime. Watch the whole story in this 5 minute video: A MARVEL-ous Trade

Okay, so that was a good example of what to do with a stock that’s up from where you bought it. Would you like a BETTER one? 😎

Nested Spreads Can Put an End to Indecision.

Has this ever happened to you? Have you bought a stock, seen it run up, and started worrying about what to do next? On the one hand, you could sell now and take profits… and a tax bill… but then the stock may continue up and you’ll feel like a chump. On the other hand, you might hold and see all the gains go away… even end up with a LOSS! What to do?

If only there was some way to put a ‘ratchet’ on a position, so that it could not surrender most of its gains but was free to gain more… and if only there were some way to participate in dividends while holding… only MORE so.

Enter RadioActive Trading and the Income Methods (‘Nested Spreads’)…

Around the time period of the MVL trade above, I was coaching a personal trading client (I don’t give advice, BTW, only provide some unique structures that may meet your goals and situation) named Paul C.

Now, Paul had been sitting on shares of MCD (McDonald’s) that he had at a cost basis of $22.15. He wanted a strategy that would:

1) Not cost anything to do;
2) Take in credits higher than the dividends;
3) STILL take dividends;
4) Become BULLETPROOF, and
5) Have an unlimited upside potential.

Wow. Tall order. Well, I was able to oblige Paul… in the strategy I crafted for him, we looked at the January $50 puts (this was in May) and they were trading for only .87 cents. This is because MCD was at around $65. In order to finance the purchase of the  put option, we further looked at a near term, June Bear Call Spread that generated $1.16. That more than paid for the put, and it was a June spread.

Can't HELP but make over 100%, but in position to do better

After its expiry, there were several months left until the January put would expire, and we could lather, rinse, REPEAT.

Check out what the risk/reward graph of that combination looked like!

Looks like ling stock... but no break-even line

It looks a whole lot like long stock, except for one thing: there is no break-even line.

http://www.youtube.com/watch?v=5yDIR4t0rjc

IN other words, Paul could not possibly lose in this arrangement, even if MCD stock went completely belly-up. He has used near term spreads to pay for his longer term insurance policies, and can continue to do so.

Okay Traders… giving you another taste of ‘Nested Spread Trades’. ‘Like’ it so far? Or do ya think I’m not playing with a full deck? Post you comments, questions, and thoughts.

Fire away, because today I only showed you a ‘Nested Spread’ that would normally risk a limited amount (the Bear Call Spread).

TOMORROW, I’ll show a ‘Nested Spread’ that normally risks an UNLIMITED amount (a Ratio Call Spread in which one call is bought, but TWO are sold). Again, though, we will risk nothing.

Other Income Method and Bulletproofing Resources

Hey, didja dig this post? 😉 Make sure and share the love by commenting, liking, sharing it with a friend. And if you’re hot on these ideas of ‘nested spread trades’, ‘Income Methods’, and ‘Bulletproofing’… here’s is a short list of other free educational resources sponsored by RadioActive Trading:

Double Dippin’… Taking Even More Premium Than Covered Calls
Catching Premium Better Than Covered Calls: The “Money Net”, Part Deux
This Simple Trick Made My Stock BULLETPROOF
Coaching Client Steve S., Makin’ Star-BUCKS…
Options Trading Wisdom From The Art of War
Taking Credit Where It’s Due
Bulletproof THIS, Part Deux
I Got GOOGLE Slapped For Saying This
How NOT To Trade Income Method #1, Selling a Covered Call
Bulletproofing a Married Put Trade
Revolutionary “NEW” Technique Turns Your Trading Right-Side-Up
A Married Put Beats a Covered Call THREE Ways
What on Earth Is a Nested Spread Trade?

YouTube:
http://www.youtube.com/watch?v=5yDIR4t0rjc&list=UUPvzT0P7mUh6IifL6NT3IEw&index=33
http://www.youtube.com/watch?v=m1Y3MnrS3Bs&list=UUPvzT0P7mUh6IifL6NT3IEw&index=1

For Free Options Trading Educational Webinars Every Tuesday and Thursday, Register HERE

For a free two-week subscription (no CC needed) to the PowerOptions “Search and Destroy” Platform for finding, managing, and BULETPROOFING these kinds of trades, Register HERE.

Happy Trading,

Kurt

About Kurt Frankenberg

Kurt Frankenberg is an author and speaker about entrepreneurship, martial arts, and trading the stock and options markets. One of several "Biznesses" he founded as a teen, The Freedom School of Martial Arts, has been in continuous operation since 1986. Kurt lives in Colorado Springs with his wife Sabrina, German Shepherd Jovi, and his ninja cat Tabi.