Using RadioActiveTrading Methods with Covered Combinations

Q. I have read The Blueprint and want to try your strategy in the following manner:

1. Buy stock XYZ today at 50.00
2. Buy Dec 57.50 Put at ???
3. Sell July 57.50 call at ???
4. Sell July 42.50 put at ???

I like this position if the stock goes up or stays in my range. If it were to go down to 42.50 and threaten an assignment, I can buy the stock on assignment, buy back the Put, or roll the put down and/or out to temporarily avoid the assignment. What other options do I have that might be better choices and more profitable? Are there any?

A. Regarding your proposed strategy, this position takes on extra risk and can limit the upside gains.

The RadioActive Trading method is based on using shares of stock that are protected by an equal number of purchased put contracts. Once an RPM is opened we want to wait until the stock makes a move before we apply one of the 9 Income Methods. In many cases, Income Method #1 might not be the best choice depending on the current conditions and forward looking expectations of your underlying security.

If you sold the 57.5 call right away, you may receive only a small premium against the initial at risk amount. If the stock moves up and you are assigned, or buy back the call, the minimal premium you received may not have lowered your at risk amount by a significant value. It is always best to wait for the stock to move up 5% or so before considering applying Income Method #1 (That being said, you always want to make sure you do sell a call that is at or above your purchased put strike price).

Now, selling a put in this position (in a sense creating a covered combination with a protective put in place) does not solve the issue of limiting risk. The long stock is protected by the purchased put. The protective put cannot cover both the long shares and the Naked (Short) 42.50 put. Yes, the put is deep OTM (which, as above means you are also going to receive little premium to offset the maximum risk) but if the stock has a substantial decrease in price you may still have significant losses on the short put position.

If you were to approach a position in this fashion, you might consider buying 2 puts (maybe at different strike prices) to cover the risk on both the long shares of stock and the short put position.

You may still be better off by waiting to enter the short call and short put position until after the stock has made a move in the desired direction.