Credit Put Spreads

PARAMETRS	CREDIT PUT SPREAD (you sell put option with a higher strike and buy a protective put with a lower strike)	BUY CALL
BREAK-EVEN	Higher (short put) strike less a shorted put premium	Strike + call premium
OUTLOOK	Not bearish: stock price won't drop below a break-even level	Very bullish: stock price will go above a break-even level
TIME VALUE DECAY	Works for you (your profit eventually grows, if stock price unchanged)	Works against you (your profit eventually decreases, if stock price unchanged)
MAX POTENTIAL PROFIT	Limited: premium received upfront(received, if the stock on expiration is at or above the higher strike)	Unlimited
MAX POTENTIAL LOSS	Limited: difference between strikes minus initial credit	Limited: initial debit
MARGIN REQUIREMENTS	Difference between strikes minus initial credit	None

EXAMPLE: 11/28/2003. Intel Corp. (INTC) looks very bullish and (according our technical analysis) should with 95% stay within the trading range (see the chart below), i.e. above 32.50. The current stock price: 33.35

INTC Strong Support above 32.50

PARAMETRS	Open Credit Put Spread: Buy to Open INTC Dec3 30 Put and Sell to Open INTC Dec3 32.5 Put with Credit 0.40	Buy to Open INTC Dec 32.50 Call at 1.60
BREAK-EVEN	32.10	34.10
MAX POTENTIAL PROFIT	0.40	Unlimited
MAX POTENTIAL LOSS	2.10	1.60
What you lose, if the stock price drops to 32.00 on expiration	Lose 0.5 cents or 0.25% per day	Lose 8 cents or 5% per day
What you earn or lose everyday, if the stock price stays unchanged (32.50) on expiration	Earn 2 cents or 1% per day	Lose 8 cents or 5% per day
What you earn or lose, if the stock price reaches 33.00 on expiration	Earn 2 cents or 1% per day	Lose 5.5 cents or 5% per day
What you earn or lose, if the stock price reaches 34.00 on expiration	Earn 2 cents or 1% per day	Lose 0.5 cents or 0.3% per day
What you earn or lose, if the stock price reaches 35.00 on expiration	Earn 2 cents or 1% per day	Earn 4.5 cents or 2.8% per day

Remember, you must be very bullish on a stock to use "Buy Call" strategies. Stocks should climb very high before your call option expires. In fact, this doesn't happen very often. At the same time, you cannot wait too long because the "buy call" time value erodes.

Our numerous back tests proved that even after strong technical signals, positive upward movements don't last long. On average, they are not extensive enough to justify initial investments in calls (see the probability distribution diagram below). For example, daily MACD signals can give you only a 12% chance to move 5% higher or more. In our example, the break-even point is exactly 5% above the current stock price.

Are you ready to take this risk? Are the risks related to Buy Calls worth the rewards? A bird in the hand may be worth two in the bush!

The same daily MACD signals give you only a 10-15% chance to drop below the break-even points for a front month credit put spread. Therefore, your chances to win are much higher.
If you are on the conservative side, go for "Credit Put Spreads".

EXAMPLE
Long GOOG Dec 390 Put
Short GOOG Dec 400 Put
Opened on Monday, December 12, 2005 with Initial Credit of 1.00.
Expired out-the-money on Friday, December 16, 2005.
Our subscribers were happy with 11% Gain in 5 Days!

Why we bet on Google? There were several reasons for this.
• The GOOG stock has formed a bottom above the 400 line (see below).
• It had the downside protection of $15 with very low chances to lose it within the next 5 days.
• Put spreads were overpriced because the implied volatility was very high.

GOOG DAILY CHART

Chart courtesy of StockCharts.com

In fact, our bet was as follows. We invested $900 for one contract (or $9/option) and anticipated to receive $100 ($1/option) in 5 days.

Why credit put spreads? Credit put spreads give you a very good chance to benefit from overpriced put options.
Why were these options overpriced? It happened because influential option traders use traditional option-pricing models that almost disregard technical signals. In our case, there was a very low chance for GOOG to drop below the 400 level. However, big option traders showed the $1 price tag for this spread.

All we had to do was just to live through the next 5 days to expiration. The beauty of credit put spreads is that time is on our side. The time value of our put options eroded very rapidly (see the chart below).

Long GOOG Dec 390 Put	Short GOOG Dec 400 Put

Finally, we finished that week with both options expired out-the-money.
Hence, the initial credit of $100 successfully remained in our hands. We have delivered to our subscribers the 11% gain in 5 days!

Auto-trading for Credit Put Spreads is now offered! Open the "Xecute" page and select "optionsmarts spreads" to auto-trade our weekly alerts. We publish 5-6 credit put spread picks per month.

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