We’ve been using the terms, “Income Method” and “Nested Spread Trade” to describe the TEN adjustments we might make to a married put position. These Nested Spread Trades are done to either:
1) take income out of the married put without necessarily selling the stock,
2) reduce the risk in an already hedged position; or
3) both of the above.
2) reduce the risk in an already hedged position; or
3) both of the above.
We make bold claims about ‘riskless’ spread trades as well. How on earth can a spread trade truly be riskless? Is it really possible to take a credit but never have to worry about a credit spread going against you? The answer is yes, provided that you understand the context in which to play the said spread… and do it correctly.
Let’s take the example of a standard bear call spread. In a bear call spread, you sell a lower strike priced call and simultaneously buy an upper strike priced call. This generates a credit, but there is a DARK side to this situation as well…
…ya might have to pay back MORE than you took in.
- The Bear Call Spread can pay a credit, but beware if the stock rises!
Here we’re showing the sale of the June $57.50 call, coupled with the purchase of the June $60 call. This generates a $1.05 credit, (per share… that’s $105 total!) and that’s a happy thing. However, if the stock goes up to $60 or higher we’re gonna have a problem.
Because we’ve sold a $57.50 call, we’ve taken on the obligation to deliver 100 shares of SBUX at that price. If SBUX goes up that will mean a problem: we gotta buy SBUX at whatever price it’s trading at expiration… deliver it for $57.50… and eat the loss.
How on earth can a spread trade truly be riskless? For example is it really possible to take a credit but never have to worry about a credit spread doing against you?The answer is yes, provided that you understand the context in which to play it.”
Fortunately the $60 call we’ve purchased keeps us out of too much trouble … if SBUX happens to be trading at, say, $100 we aren’t in a pickle with a ‘naked’ call. We can use the $60 call to pick up 100 shares at only $60, no matter what the open market wants for SBUX.
When we deliver those shares at $57.50 that we buy at $60, that’s a loss of $2.50 ($250 total), right? But that $2.50 loss is lessened by the $1.05 credit we took up front. So the maximum possible loss on this spread trade is the difference of $1.45 ($145).
Whew.
You might have picked up $105, but may LOSE $145 instead!
“But wait,” you might be saying. “What was all this about a RISKLESS Spread Trade? Didn’t you say that a credit spread could be done that would take a credit but would not risk anything?”
Yup. I did. So, remember I said it would be a “NESTED” spread trade. Well, what do we ‘nest’ this Bear Call Spread in, in order to make it riskless?
The risky part about doing a Bear Call Spread play in the first place is that you don’t own the stock. That’s what creates all the concern in the first place.
Let’s review: Seling a call takes a credit, but leaves you open to the liability of perhaps having to deliver stock at a lower price than it’s currently trading. To satisfy that obligation, you’ve now got to go out and buy the stock. The upper strike call keeps you from getting into TOO much trouble for taking a credit… BUT!
Hey, doesn’t all this bruhaha about going and finding stock to deliver just go away… if you already OWN the STOCK?
Heh. Smile, young grasshopper. You’re beginning to see how ‘nesting’ might work.
Let’s look at another position with SBUX, a married put trade: Here, I’m showing SBUX with a cost basis of $54.40, although right now it’s trading at $57.95 . Never mind about the fact that Starbucks is currently priced over three dollars higher than the cost basis I’m showing; that’s a topic for another post.
What I’m doing here is showing a married put position that is that is completely neutral: the cost basis of the stock and the put combined is exactly equal to the strike price of the put.
There is no risk for this position anymore, but there are no guarantees of a gain either. Take a look at the graph:
Stock plus put. When cost basis for stock is reduced, there may be zero risk; BULLETPROOF
We call this married put position “Bulletproofed” because the cost basis of both the stock and the put is equal to the right price of the put. So there’s no risk left in it, but there’s also no guarantee of a gain… If Starbucks stays below $60 all the way until expiration we end up with nothing.
SO now back to our Bear Call Spread, selling the June $57.50 call and simultaneously buying the June $60 call. We’re going to generate a dollar and five cents credit, right? Only now let’s do the bear call spread in the context of the married put position.
This changes everything. Because we have the stock on hand to deliver… there is no longer any risk to writing a call. In fact, when we do a bear call spread it’s as though we get paid to own the upper strike call. Cool? Yeah, REAL cool. Because before, we had a protected stock but no guarantees. NOW we have a protected stock and we’re going to get to keep over a hundred bucks no matter which way she goes. I’m going to enter all four legs into the PowerOptions Custom Spread Tool:
So we’re combining the married put, which insures Starbucks clear out ’til October… with a near expiration June $57.50/$60 bear call spread. The result is a guaranteed return of the $105 credit from the bear call spread. That’s retained… whether Starbucks goes up, down, or sideways.
Take a gander at this pretty graph with all four legs in place:
Riskless Spread Trade
Unlimited Upside potential for the Married Put, guaranteed credit from the Bear Call Spread!
This is why I can claim that this bear call spread… which is properly ‘nested’ within a married put… has no risk. If we are called on to deliver the stock, it’s already on hand.
That totally neutralizes the risk posed by doing a bear call spread. The context of stock ownership is the secret to “Nested Spread Trades”.
These principles and techniques are just a few of what you will learn from “The Blueprint”, which teaches how to limit risk, take income while you wait, and perhaps even “Bulletproof” stocks in your account. To get on the waitlist for the next release of The Blueprint, click this link:
Click me! <== to get on the waitlist and get the free mini-course!
Hey, did ya ‘like’ this post? Say so. Think I’m a total harebrain? Say that too. Bring on the comments, Traders! Glad to give ya some more brain candy. Tell me what you think and don’t be shy.
Happy Trading,
Kurt
Other posts on this blog featuring Income Method #6:
Taking Credit Where It’s Due
Bulletproof THIS, Part Deux
I Got GOOGLE Slapped For Saying This
All Screenshots are of PowerOptions Graphs on the Custom Spread Tool.
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
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Looks pretty good, Kurt. If you’re called out (above $57.50), I assume you just sell whatever time value is left in the Put? That would reduce your costs even further, but I guess that couldn’t be put into the graph because it is dependent on so many factors, i.e., Time to Expiration, Volatility, etc.
Well that’s a VERY good question… because there are actually a number of different things you can do. For example, before getting called out you may close the long call at a profit while rolling the short call out to the next month. You might also roll the whole bear call spread, delaying your time to let go of the stock while taking a credit. You may allow assignment, then sell near term puts against your long term put at low or no risk. There are a lot of… ‘options’. 😉
This is cool! But help me here…In a Bear Call spread it seems like the purpose of the purchased Call (the 60 Call in this example) is to provide some “coverage” against infinite loss. If we already own the stock and would deliver it if called away, why not just sell the ATM/OTM call? What purpose does the 60 Call serve in this nested situation? Again, I would typically it is to avoid selling a naked call. But because we already own the stock it is no longer uncovered/naked. In the example if we only sell the call we collect twice as much premium ($225 vs $105). Thanks! — BT
Good observation Barry… you can in fact pick up more premium by simply selling a call. However, the benefit of doing a bear call spread is that you can also leave your upside open in case the stock takes off for the moon. Ever feel like a CHUMP for selling a call at too low a strike, or for too little premium? The bear call spread will offer some redemption 🙂
Happy Trading,
Kurt
Very interesting idea, Kurt, but sadly I can’t get TradeMonster to show similar good news if the stock price drops. My profit and loss curves cross zero below a stock price of $58, while yours remain happily in very positive territory.
I know my charts are for today’s prices (May 2nd 2012) where SBUX has moved up to 57.92, but I’ve tried to emulate the structure of your 4-legged trade.
Please see my screenshots at:
http://img851.imageshack.us/img851/8354/radioactive20120502.jpg
Of course the chart at top left at imageshack.us, doesn’t show what would happen if the written call option was assigned when the stock price went above the strike price of the option.
On assignment they’d give you the strike price for the stock they took off you (which would show a profit) and you get to keep the option premium, and presumably they’ll be some profit on the long call unless time decay is greater than the appreciation due to the stock price rise (or volatility was unhelpful).
If the stock price did fly upwards, you’d be praying for assignment so you didn’t have to take the $192 loss. Assignment is not guaranteed though (indeed I understand that even after the expiry date when the written option is deep ITM, the OCC can still declare a “not to be assigned” instruction to a stock symbol). But let’s hope assignment does occur if the stock flies.
Do we now have to question our broker’s reporting of the P&L – would you expect such a marked difference?
Thanks for a most thought-provoking post.
Wow. You should contact TradeMonster and let them know their platform is off. If you have a stock + put whose combined cost basis is equal to (or less than) the stike price of the put, you have a bulletproof position. Then, writing a near term bear call spread using the parameters I’ve shown definitely takes a credit without you having to ‘pay it back’… and if the stock goes DOWN you keep it all plus may liquidate your put and stock clear out to October. You might even play another one of these bad boyz in that time 😉
@James. Having lost your stock due to assignment, you could consider keeping the Put and re-purchase the stock by exercising the long Call and get the stock again at the long call strike price, but your effective purchase price for the stock would then be the strike plus the long call option price (61.18).
What would you recommend Kurt, as the best play after assignment?
Kurt, to be properly nested, must the call you sell be less than the strike of the protective put and the one you buy , correspond to the strike of the put?
Not necessarily. In the case that I’m showing, the strike of the short call is lower than the strike of the put. That ‘never, ever sell calls that are below the strike price of your put’ rule in The Blueprint is relaxed somewhat in the case of this nested spread. But you can still make bonehead moves with this if you are not watching closely. I recommend plugging your trade params into PowerOptions’ Custom Spread Tool at http://www.poweropt.com/rat.
Happy Trading,
Kurt
Sorry Kurt, I should have continued on my previous post. I’ve been trading the options animal dynamic collar techniques, and many times the put is only in place when earnings are near, or the technicals show a short term downward change in trend. Also , they use additional income trades to lower cost basis over a legnthy period of time, sometimes using out of the money longer dated coverd calls to pay for the addition of the married put. I usually do these on dividend paying stocks that I would like to keep in my portfolio for at least a year or more. It seems to make for alot more trades and management than your system. Would you care to comment?
So Options Animal only places the put when an expected news event is on the horizon… interesting. I ‘put’ on the protection at the beginning, and may ADJUST the put near to earnings. For example, Income Method #3 or #4 can BULLETPROOF a stock just before earnings; with the adjusted put protection in Bulletproof status you may win but cannot lose from a sudden downturn.
The fella that was instrumental in organizing my presentation at MIT did just this with NTAP. He began with a married put that had only 4% AT RISK. Then, along the line somewhere he did Income Method #4 and made it Bulletproof. Then he forgot about it! Fix and forget… the polar opposite of day trading. Anyway, at the end of his trade he saw that his NTAP position, which he held during a serious drawdown, came back and rewarded him with a 30% gain. Not bad. He started with 4% risk, went to zero risk, and without any further maintenance realized a pretty solid gain.
Dunno if it seems I got off-topic… bottom line: LESS management is always my goal. The (continual) protective put accomplishes that neatly, and bulletproofing rounds out the deal even better.
Happy Trading,
Kurt
What about the interest costs of buying the shares and the put?
Not sure what you mean Peter. Are you referring to commissions?
Happy Trading,
Kurt
Yes, very important to know what to do with that put. The trade is not over when your stock gets delivered away. Kurt, over to you for the hypothetical next step to clean up the position.
You may liquidate the long put, which is likely to still have some value because it’s far away. But that’s only one of several ways you might manage this position.
One thing I like to do is sell calendar puts against the leftover long put. IF I’ve already gotten the capital out of the original position plus a little profit… it’s possible to pick up more premium at no risk. I call that Income Method #7. You might figure that one out on your own but to save you the trouble I wrote about it in my book, The Blueprint. There’s a specific way to do it so you don’t over-leverage.
I tried subsituting today/s figures using your formula above and it always comes out at a loss. I used Starbucks and Oct 60 put and sell 60 call and buy 62.5 call Junes.
Okay, I see why you and Lagoonboy are having trouble. Y’all didn’t read where I said “never mind that the cost basis is three dollars less than today’s… that’s a topic for a whole other post.” See, I’m using an already-bulletproofed example (Bulletproof: adjusted cost of stock and put is equal to or lower than the strike price of the put) in order to illustrate how the NESTED position changes things. We go from a $0.00 risk to a -$1.05 risk. I showed selling the June bear call spread ‘nested’ within the bulletproofed October married put.
I showed it that way to put the question in people’s minds, “So how do we get to this Bulletproof status anyway?” and set up my next post. But just so you know… If I HAVEN’T bulletproofed… If my October $60 married put risks $400 and in the context of that I sell a June $57.50/June $60 bear call spread against for a $1.00 credit… then my risk becomes $300 instead of $400. But the upside is still unlimited. I never have to ‘pay back’ on that nested credit spread.
Clear as mud? Hope not. Keep the Q’s coming Frank!
Happy Trading,
Kurt
Kurt, I noticed your Oct put is 5.60 ITM, with a price of 5.60.
How can you buy an option with no time value? I would think that you’d pay 7.00
Hi Ray! See my reply to Frank please. I used an already-bulletproofed position to show the effect that a nested spread has on it. But say you did pay $7.00… then you have a position that risks ($54.40 + $7.00… $61.40 total cost of married put) – ($60 guaranteed liquidation price of married put) = $1.40. THEN, by applying a credit of $1.05 from the bear call spread, you now have a married put that risks $1.40 – $1.05 = .25 cents. Get it? The premium from the bear call spread reduces the cost basis of the stock. Do this enough times and you have no risk left in the position.
Happy Trading,
Kurt
Hi, Kurt,
Great job on your RPM methods! Quick question on nested spread trade – specifically the Income #6 method. Previously you mentioned trying to get minimum income of $1.85 for a $5 spread, or near about 35% income vs the spread interval.
Do you have any experience and ideas/suggestions on how best to handle high-priced volatile companies like AAPL, CMG, V, PCLN? These have high stock prices. A $5 or $10 spread interval for IM#6 on these stocks would not generate sufficient income to cover the married put time values.
I was looking at using a spread interval size in the area of 5% to 7% of the actual stock price. So, if AAPL is at $565, I might look at a $25 spread interval try to get income of at least $8 on this $25 spread interval.
Any ideas are appreciated! Keep up the great work. Thank you.
Randi
Great ideas. A larger ‘interval’ may also be attained by using Income Method #5… it pays out over a very large territory. When IM#5 is set up at a small credit, it’s likely you may be paid a second time when you exit.
BTW this is more of a Fusion Subscriber kind of a question, so please submit this kind of Q to support@radioactivetrading.com. Thanks Randi,
Happy Trading,
Kurt
Hi, Kurt,
I forgot this one also. In your CD on IM#6, u used the GIS example where the IM#6 call credit spread income received nearly paid for the married put time value – almost in entirety! Very sweet!
1. Does Power Options allow us to screen IM#6 setups where the nested credit spread pays for at least 90% of the married put’s time value?
2. Alternatively, are these unique situations primarily only present when the stock’s implied volatility is excessively high – thus making the At-The-Money credit spread ideal to sell for premium income? In your GIS example, the implied volat for GIS back in Nov 2008 was extremely high.
Most of the time, I can find good IM#6 setups – but rarely am I able to find one in the front month that nearly covers all of the married put time premium.
Thank you for your help and insights/experience here!
Regards,
Randi
Hi Randi!
You can use the Custom Spread Tool on PowerOptions (www.poweropt.com/rat for a free two week trial) to see if your bear call spread, coupled with your stock ownership, truly produces a riskless spread. Sometimes they don’t. The way to check is to see if the bottom of the ‘checkmark’ stays above the break-even line. If it does, you have a winner. Please let me know if you need further help, and my apologies for the lateness of this reply.
Happy Trading Randi,
Kurt
There is no free lunch! If your stock declines in price you have increased the ‘bulletproof’ value, but if the price rises you are sacrificing potential gain. Check the values at $65: 643 without the spread and 602 including the spread. Real examples show the loss approximately equal to the at risk amount of the spread.
Agreed… there is no free lunch.
That said, I still buy insurance on my house, my auto, my health and my very life… how ’bout you? 😉 It’s important to realize what this hedging thing is and what it isn’t. I don’t claim that using a married put will enhance your returns. I claim that you’ll still HAVE more to invest if’n you use them when it matters. And you won’t know if it’s going to matter until after the fact.
In other words… the put option is like a lawyer. Sucks to need one. Sucks WORSE to need one and not have one.
Leon, check out the Income Methods… they help with the price of the put option, sometimes even to the extent that they completely PAY FOR the put option. In these cases, it’s such a no brainer I don’t know why anyone would close their mind to the possibility. Having unlimited upside potential, while having limited… or ZERO… loss potential truly encapsulates the saying, “Cut your losers short, let your winners RUN.”
Happy Trading,
Kurt
Kurt: Just attended one of your web presentations. What would you recommend to do with 200 shares of NEM which I bought in August 2011 and my current basis is $47 per share with the last selling price at $48.57 per share? Buy a put out of the money or in the money 5 or 6 months ahead? Interesting stuff. I do own alot of long term options like Coke and McDonalds that have international businesses. Thanks
Hiya, Jerry! In accordance with SEC and other regs, I don’t ‘recommend’ anything. However, I will tell you that I never enter a position without the hedge of a protective put option.
I haven’t checked the price of NEM recently, but if it is still ‘up’ then you will likely get the put at a lower price than if you bought it simultaneously with the stock. I always like to get it several months out and a strike or two in the money.
Glad you said it was interesting stuff! Come to the free webinars and you’ll see stuff that’s even more interesting.
Happy Trading,
kurt
If you have a Bear Call Spread and the stock shoots up, would you ever sell the long call for a profit and allow yourself to be called out (since there is now only a covered call left) or would you just roll the spread?
It seemed to me that you could double-dip by making money on the long call and the covered call. You would have to be willing to get called out of course which is typically what you try to avoid but it seems that a nice return could be in order.
I don’t understand how come you P/L graph shows profit of $367 when stock is $60.
At $60 stock shares will be worth $6000, put will be $0, $57.5 call that I sold will cost me $250 and $60 call that I bought is $0. My end balance is $5750. Meanwhile I spend $5895 to get into this trade: $5440 for the stock, $560 for the put – minus $105 for the spread. Result is that if stock end up at $60 at the expiration of the Oct PUT I will loose $145. Where is profit of $367 came from?
Hi Alex,
You’re making the assumption that the put will be priced at $0… don’t worry, rookie mistake. MOST folks that look at my nested play setups forget that an at-the-money put option isn’t zero until expiration.
If you look again, you’ll see that the bear call spread expires in JUNE, but that the put protecting the stock expires later in OCTOBER. Therefore, if your stock is at $60 on the first expiration Friday… in June… you will:
1) have your shares called away at $57.50
2) keep your $1.05 credit
3) be able to sell your put option for the remaining time value
It’s #3 that is throwing your calculations… you’re not allowing for the fact that a $60 put with four months to go, will still be worth quite a bit. Black-Scholes sez about $4.00. That’s where the difference is coming from.
Hope that answered your Q, Alex! Go to http://www.poweropt.com/rat and sign up for a free trial to the platform that will prove this.
Happy Trading,
Kurt
Hi Kurt,
I’m a new comer and have been playing with catchup game by searching for something more safer in option trading after more than a year of trading caller with total 14% lose of my account size (with 65% win rate). I’m stuck.
Your RPM is very interesting and I will keep reading more posts. I hope you won’t mind if I ask the following question: for example, when SBUX was trading at $60 at that time,
Original stock price: $54.40
Put cost : $5.60 (guarantee stock price at $60)
Sold a call : – $2.23 (at strike price $57.5)
Buy a call : $1.18
—————————————
Total cost per share: $58.95
Once the stock was called away at $57.5 at expiration date while stock was at $60, the the loss would be $1.05. Sure, the remaining Put can be sold for some compensation (hope there was still some value left), but that would cape any profit to certain level. Therefore, that “Unlimited Upside potential for the Married Put” in this scenario would not be true once the stock was called away. Is this true? or I missed out something important.
No matter what, I still love the idea of protect investment capital from beginning.
Your comments and insights/experience are greatly appreciated.
With regards,
Shang
Hi Shang:
The married put by itself is unlimited upside potential, it is possible to make management trades to the original married put, once that is done, sometimes the upside potential will be limited, but most times it is not. We teach and try to only find trade adjustments that WON’T hinder the upside potential. After all, we originally entered a married put (bullish position) because we were bullish! It wouldn’t make much sense to always change the trade in a way that hinders that bullish move if it happens. You can see from the graph the upside potential isn’t hindered. We teach all of the adjustments to a married put in our 250 page book, The Blueprint.
Hi Kurt,
This is my setup stock symbol MT.
Price 14.72
Long term put mar 13 stike 15 at 2.48
17.20
Guarantee 15.00
Risk -2.20
ITM Credit call spread:
sep 12 strike 12 at 2.71
sep 12 strike 15 at -.52
Net Risk -.01
Kurt the problem is my software says maximum loss of $82.14
Am I not calculating things right? Because I have two different numbers, I am not going to trade until I know what is right. BTW your blueprint manual is outstanding! Thanks….
Hi Trendtradeforlife! Sorry we missed the SEPT trades you have posted here, I did a mock-up of this trade on the PowerOptions Custom Spread tool. I assumed 1 contract all the way around and I assumed you bought the 12 strike calls and sold the 15 strike calls. If that is all true (and we assume OCT options now since SEP is expired) it appears that the max risk on this trade goes up to over 23% – NOT over $82. Unless you were thinking of this as a ratio spread and didn’t post that.
More likely, you planned to sell the 12’s and buy the 15’s which looks a little more normal. The max risk is decreased (right direction) to about 6% in the whole position – but the trade is not bulletproof yet. (again, assume using the OCT calls)
If you need to analyze this more, try using the Custom Spread tool on PowerOptions. Send us an email to discuss further!
Lot’s of flaws here…
You have forgotten the fact that when the stock goes up, your bear call spread is offset with the stock, but then you are left with a long put, which loses money.
You have basically a bear call spread, and a long oct 60 call.
(put + stock = call). So, same here… you will lose inside the bear call spread, and will start making money back going through the 60 strike…
D.
Hello D, If we break down the individual legs we would see that the put and the short call would work against us as the stock rises in price. As that happens, we would be gaining on the long stock and the long call that we were paid to own. The gains in the stock will be higher than any loss on the put option as the put does not lose 1:1 with the stock.
This nested spread trade allows us to solve the problem of simply selling the call against the married put position. If we just sold the 57.5 call our gains would be capped. Using the nested spread trade allows us to keep the unlimited upside profit potential while still generating premium to lower the initial at risk of the married put.
Each of the 11 income methods discussed in The Blueprint has a detailed CEGA model (our decision making model) that goes along with it. As you can see by the final profit and loss chart in the article, the adjustment for this trade would benefit us if the stock was trading at any price at expiration. If we had a strong sentiment (or a crystal ball) that the stock would be trading between $57.50 and $60.00 per share at expiration, we may use a different adjustment. However, in this case, we would realize a good profit if the stock was trading at any price at the short term expiration.
Thanks for the comment, and let us know if you have any other questions about this nested spread trade!
[…] Simple Trick Made My Stock BULLETPROOF Coaching Client Steve S., Makin’ Star-BUCKS… What on Earth Is a Nested Spread Trade? Options Trading Wisdom From The Art of […]
[…] Also… for a teaser about how to continue risklessly extracting income from a position like this, check out this post: “What On Earth is a Nested Spread Trade?” […]
I’m having a problem if the stock at the spread’s expiration (excluding fact that there is still premium left in the Oct put) closes at 60. 60 put=0, 60 call=0, Cost of bulletproof position =60, Have to sell at 57.5. Looks like a $1.45 loss. ?????
Hmm…. I think you are right that the total position does not ever lose money. But the question is does the spread ever lose money compared to not buying the spread. And the answer is yes, it can lose $145. If SBUX goes to $60, you have $145 less with the married put + spread than if you just had the married put alone. The spread has exactly the same risk with or without the married put position. It’s just that you are counting the gains from the married put position to offset the loss in the spread position as SBUX rises from 57.50 to 60. But that doesn’t mean they aren’t losses.
SO the luxury, Paul, in doing Income Method #6 is that you can GRAB cash right now when you think your stock will go down or drift along sideways in the near term. BUT..! I fyou happen to be wrong, there is no capital risk to doing the play.
If you appreciate IM#6… you will probably LOVE IM#5 and IM#11. These two are designed to take a play that normally has risk… one has INFINITE risk… and tame it down so that you can’t be hurt. But if your stock moves along sideways or even a little up, it will actually pay you to sit on it while you are gaining in the stock.
Just brilliant if I say so myself 😎
Come to a webinar entitled, “The Money Net” to check it out.
Happy Trading,
Kurt
Problem, if the stock goes down, your put will only protect you by 50% or what ever the Delta is. If SUBX goes down 10 dollars, you lose 1000 bucks on the stock, and only gain 5 dollars on the put option, or 500 bucks on the contract. Of course you can still have the 100 gain on the call spread. Still a loss of 400 bucks. So there is no such thing at riskless.
Kurt, You obviosuly posted this some years ago, but I just now came across this thread. In your example above with a “nested” trade, there is one thing that does not make sense to me. I mean as far as calling it “riskless”. First, in your example, you put on a married put at zero cost, which is really rare. In other words, your put had zero extrensic time value I rarely ever see that, but I will take your word that it can be found. Ok, here is my real question… If SBUX closes at $60 at expiration, the stock will protect the written call above the $57.50 + $1.18 credit = $58.68. However, the stock cannot protect the call and the married put at the same time. The married put would lose value between $58.68 and the $60 expiration price, meaning the loss in the bear call spread would be covered by the stock, but the loss in the put between $58.68 and $60 would not be covered. This is not a riskless trade. The loss would be $1.32 at expiration.
Hiya David!
Here’s the answer: NOPE.
😉
You may have glossed over the part of my post in which I said “Never mind about the fact that Starbucks is currently priced over three dollars higher than the cost basis I’m showing; that’s a topic for another post.”
It’s important to note that in the example, the married put in question had $3 of its cost basis mitigated somehow. I don’t offer an explanation in that post… like I said that was a topic for another post but that’s the context.
SOOooo… how is it possible to do a riskless bear call spread?
In the situation I referenced, the married put has a net cost basis of $60 per share… $5.60 for an October $60 put and $54.40 per share for a 100 shares. It’s in this context that the married put now has no risk of its own, at least until expiration.
Within this context, we then insert a $57.50 X $60 June bear call spread for $2.23 X $1.18 = $1.05 credit.
Incredibly, the four legs… the stock, the protective put, the short and the long call… make for a structure that has a net negative risk. That is, the credit from the bear call can never “come and bite you”. Why?
If the maximum loss from the June bear call happens, the October put still has enough time value that it can be closed without a capital loss.
This would NOT be the case if the put also expires in June.
SO:
if SBUX closes under $57.50, the June bear call spread realizes its full credit, profit is realized and the process can be repeated.
if SBUX closes between $57.50 and $60.00, the bear call spread can be ‘managed’ and the rise in SBUX’s value offsets it at a profit.
if SBUX closes above $60, the stock gets liquidated for what we had in it… the put will be worth SOMEthing… and the long $60 is still in play.
In all three scenarios, guaranteed profit is realized.
To see how we can have the required “Bulletproof” married put that makes this work, go to my post http://blog.radioactivetrading.com/2011/07/taking-credit-where-its-due/
Happy Trading!
Kurt
You are correct, not extrinsic value. Where you can find a ITM contract with 0 ext value?. I do not see this position working at all. If stock raise, your long put will lose value and the gain from the stock will compensate this loss but then the spread will be exposed since it will be ITM.. I have tried for a year multiple positions to find a riskless trade and I found that there is only way to set a free risk trade. However, requirements and margin are very high..
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