WHO sez you can’t grow money on trees? Why, I’ve been doing it for the last two and a half months… ON Dollar Tree, (DLTR) that is!
😉
Author’s Note: Ahem. Real quick, I need to emphasize that what follows is not an endorsement to buy or sell shares or options on DLTR stock. I’m simply using a recent couple of trades for sharing purposes. I think you will be amazed at the PLAY I’m going to share with you today, not pumping up demand for a particular company. That said…
Get this: I recently showed my FUSION Subscribers a riskless spread trade in which I picked up a credit… watched and waited for a while… closed that riskless spread trade for ANOTHER credit… and then I just recently put on another riskless spread. Indeed, money seems to be growing on my DLTR Dollar Tree.
Whoa, there Nelly! …Kurt, did I read that right? Did you just say you could put on a spread trade at a credit and incur ZERO RISK? And what’s this about CLOSING that same spread for another credit.
Heh… it’s TRUE… it’s possible to make a riskless spread trade. Provided of course that the context of that spread that it’s nested inside another position.
Take a look at this cool setup for DLTR first:
| Bought shares of DLTR | $79.85 | |
| BTO May 2012 82.5 Put | +$8.80 | |
| Total Investment | $88.65 | |
| Guaranteed Return | -$82.50 | |
| Total amount AT RISK | $6.15 | or 6.9% |
Now that’s the beginning point. I start all of my trades off with protected shares of stock; no matter how bad the market goes against me, I can’t possibly lose more in the above trade than 6.9%.
Now for the cool, “riskless spread trade” part:
On the same date (October 13, 2011) of the above setup, I sold to open four November $82.50 calls. Then, using SOME of that premium generated, I also bought to open two November $80 calls. Here’s how that went:
Sell to Open FOUR November $82.50 calls at $1.80 X 4 = $720 received
Buy to Open TWO November $80.00 calls at $3.10 X 2 = $620 spent
TOTAL Income = $100 bucks!
Now, here’s the deal. NORMALLY, a ratio call spread like the one described above would impose INFINITE risk. That’s because there are FOUR short calls and only TWO long calls. As the stock goes up higher and higher, that makes for a worse and worse situation because you would have to buy stock at whatever price it was trading, to deliver it at $80. Not cool.
Of course, that is the situation when doing the Ratio Call Spread all by its lonesome. But remember? I was showing it in the context of ownership of 200 shares of DLTR stock.
Ta-daaa! No risk. If DLTR were to have gone up in that timeframe, I would be obligated to deliver 400 shares at $82.50 all right… but I would have gotten 200 of them at $79.85 (see the setup above) and could get 200 more at $80 (because of the two long $80 calls I’ve been paid to own).
Well, it wasn’t to be. I had hoped that DLTR would go and stay above $82.50 a share but come November 15, just three days before November Expiration DLTR was trading in the low $78s, high $77s.
Not to worry! Since it seemed almost a GIVEN that DLTR would not get back to $82.50 (it didn’t, BTW) by expiry… I did the following move to close the ratio call spread:
Sell to Close TWO November $80.00 calls at $0.85 X 2 = $170 received
Buy to Close TWO November $82.50 calls at $0.30 X 2 = $ 60 spent
TOTAL Income = $110 MORE bucks!
So to date it’s $210 income into the account, being set against the cost basis of those 200 shares of DLTR.
The puts are still in place.
And on 12/16 I was able to put the following ratio call spread AGAIN:
Sell to Open FOUR January $82.50 calls at $2.30 X 4 = $920 received
Buy to Open TWO January $80.00 calls at $4.00 X 2 = $800 spent
TOTAL Income = $120 bucks AGAIN!
That’s another reduction in the cost of the stock that’s protected by the May $82.50 puts. If this keeps up, soon I will be BULLETPROOF, meaning that there will be no remaining risk at all.
Now, I know what you may be saying. “Why not just sell a covered call to generate those premiums?”
Well, the point of doing these ratio call spreads is to CAPTURE a little extra green when the stock DOES go up. In the case of the November ratio call spread, that didn’t work out. Although it IS nice to get PAID to close a trade.
BUT..!
The really cool thing that MAY happen this time around is that DLTR may close above $82.50 this time.
Should that happen, two of those calls will cause my shares of DLTR to be liquidated, unless I do something to keep ’em.
My puts will still be worth something, so I’ll cash them in too.
What will that leave in place? Oh, only two bull call spreads… formed by the two remaining short calls, offset by the two LONG calls… that I got PAID to own.
Catch that? It means that since all those aforementioned calls will be closing in the money… since DLTR is above $82.50… I get to collect the maximum payout on two bull call spreads ($500 extra!)… and let’s say this again: I got PAID to own those bull call spreads.
Ahhh.. the joys of trading RadioActively… 😉
Hey, come check out the year-end special we have going now on RadioActive Trading education materials. Since they are 100% guaranteed, there’s no risk to THESE trades either…
http://www.radioactivetrading.com/products.asp
Happy Trading!
Kurt
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Hi, i took part in your last seminar. I’m really trying to understand exactly how you set up these risk free spreads. I assume the one above is an example. In the scenario you outlined above if DLTR were to rally the most you would make is 3.61% because your combo of the long put and the short call would be moving against you and the long call wouldnt be able to offset the rally enough. THe flip side if the stock drops the premium you generated from selling the call and the long put wont be enough to offset the loss.
Well, not sure where you got the math for that 3.61%, but suffice it to say that there are BOATLOADS of ways to manage an Income Method #5 “Money Net” play.
The stock did in fact rally as you had mentioned. If it rallied more than it did, I would use another management technique than what I’ll outline here. But what I’ll do here and now is tell you how I managed the stock going above the short call’s strike price of $82.50.
As you may recall, there were two Jan $80’s purchased for $4.00 each, and FOUR Jan $82.50’s sold for $2.30 each. That makes $920 IN, minus $800 OUT for a net credit of $120.
DLTR went over $84. In the closing hours of Expiration Friday on Jan 20, 2012 I was able to close TWO of the FOUR short calls for $2.15. That’s $430 OUT.
So what has happened? Well, now I’ve made it so that my stock won’t get called away, although the short calls encumbering it were quite in the money. But it cost me $430 to do so.
Or DID it? See, after closing TWO of the FOUR short calls, there’s still two left. Of course, those two calls are not ‘covered’ by stock… they’re ‘covered’ by the two long $80 calls I mentioned earlier.
In the middle of the night, my broker exercises my right to buy 200 shares of DLTR at $80. Then, he also assigns them at $82.50 to satisfy the two short calls. That’s $500 into the account, while I have spent $430 to make it possible.
In short I got paid $120 ($920 – $800) to put ON the ratio call spread… then $70 ($500 – $430) more to MANAGE it.
That’s $190 to hold onto a stock that went up during the time I had this spread in place. If I had only sold two $82.50 covered calls I would have picked up $2.30 X 2 = $460, and paid back $2.15 X 2 = $430 for a net profit of $30, barely enough to pay for commissions. But as it was, the $190 Income IN, PLUS the privilege of continuing to hold a stock that was way up from its purchase price… was a pretty happenin’ way to go. Beats the shi—take mushrooms out of covered calls 😉
Happy Trading,
Kurt