Clarification on BULLETPROOFING…

A certain someone wrote in after seeing the last blog post, which showed how a RadioActive Trader might build a fence around his stock so that if the market goes against, HE cannot be hurt… but he didn’t quite understand the implications.

I still don’t understand what I’m missing on that example… how is the Bear Call position “Bulletproof” without putting another option in place?

Regards,
Ray D.

MY REPLY:
Hi, Ray!

It’s not the Bear Call Spread that is Bulletproof… it’s the stock. That is, if HL goes down there is no way that our investor can be hurt because he has locked in a sell price of $9, for a total ‘cost’ of $9.06… and to boot the Bear Call Spread is paying him .33 cents!

If HL goes down or even sideways, that .33 cents will be locked in… the net cost of the stock plus the put will be ($9.06 – .33) = $8.73… so the position cannot hurt him if the stock goes down anytime before Jan expiration.

On the other hand, there is no limit to how much he can make if the stock goes up. For the Bear Call Spread to hit its maximum loss of .67 cents, the stock has to go up by more than a dollar. If it DOES go up by more than a dollar, then our investor gains a dollar on the stock side… get it? If you look at the graph, there is no way that this play can lose anything and unlimited upside in case the stock goes up.

Now, as you might have guessed there are some management techniques that come into play if the stock goes up, to keep it from being assigned… but that’s why I took the time to write a book about it 😉

Happy Trading!

Kurt

Traders, let’s take a look at the risk/reward graph from the trade in question. The investor that had originally written in had shares of HL at a $7.31 cost basis. I pointed out that he might at that time (as HL was trading at $7.98) pick up a January 2012 $9 put option for $1.75, and simultaneously sell an October 2011 $8 call at .60 cents and buy an October 2011 $9 call at .27 cents for a net, GUARANTEED GAIN:

The above graph represents what adding those three options… a January 2012 $9 put, a short October 2011 $8 call, and a long October 2011 $9 call… would do to the stock already purchased with a cost basis of $7.31.

As you can see, there is no longer the possibility of losing. AFTER October expiration, we might be looking at a new position that includes only stock and a put option, and the combined cost basis for both of those instruments being LESS than the strike price of the put. This is what we mean around here when we say a stock is Bulletproof.

Happy Trading,

Kurt

P.S. Hey, wanna come and see ANOTHER way you can take all the risk out of owning a stock, but leave the upside potential completely open? Come take a look at one of our free Webinars twice per week held LIVE during market hours, or an archive at www.radioactivetrading.com/webinars.asp