Explore Your Options  |  JUN 2006

Explore Your Options by Tom Gentile

Stocks & Commodities V. 24:6 (73): Explore Your Options by Tom Gentile Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it to our website at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. MAX PROFIT ON A BEAR PUT SPREAD Q: On March 30, I entered a bear put spread on XYZ using January 2007 leap options. With XYZ near $451.00 a share, the spread consisted of buying a 450 put for $45.90 and selling a 440 put for $40.40. According to my calculations, the maximum profit is $4.50 per spread if XYZ falls below 440. However, on April 4, I checked the trade and found that XYZ was below the 440 strike price. My understanding was that I could close the trade below the 440 strike for the maximum reward of 450 (minus commissions). Yet when I did the math, it did not all add up. What happened? A: The trade’s analysis is correct in many respects. A bear put spread is created by buying a (long) put and selling a (short) put with a lower strike price. This trade will generate profits if the price of the underlying asset falls. The spread is similar to buying a put, but the sale of the short put helps reduce the cost of the trade. This is a popular strategy for playing a market to the downside.

by Tom Gentile