Boca_Bobby Basics

[boca_bobby]

Let's try to remember why would sold the PUT spread in the first place.

We sold $10/PUTS for Jan of 2011.

We bought $5/PUTS for Jan of 2011.

The difference between the two prices is the premium we will receive into our accounts. This premium is used to purchase CALLS in Aug of 2009.

So, now to address your question. How can we reduce risk to the PUTS if the PPS of CQB goes to $20 and then has a massive retrace of 50%? Let's examine this assuming the $20 PPS is accomplished before the expiration of our Aug of 2009 CALLS expire.

We were buying the $10?CALLS for Aug of 2009. With a $20 PPS on the stock, our CALLS will be worth a minimum of $10. Here's the math.

PPS - Strike Price = Potential Profit

$20 - $10 = $10.00

But remember that each contract is for 100 shares, so we need to multiply each contract by a factor of 100. Thus:

Potential Profit X 100 shares = Contracts Potential Value

$10.00 X 100 = $1,000.00 per contract

So we would sell the 15 contracts I spoke of for a profit of $15,000! But at the same time what do you think will happen to the value of our $10/PUTS that we sold that expire in Jan of 2011? What happens to the value of the $5/PUTS we bought that expire in Jan of 2011?

That's right. They both go down in Value as the PPS of CQB goes up. So after the PPS hits our $20 figure you have posted and we sell our CALLS for $15,000, we immediately buy back the $10/PUTS we sold. It doesn't matter the price since it will be lower than what we collected in the first place.

We would leave the $5/PUTS alone. No need to try to sell them. We just hold on to them since the value will be almost $0.00 anyway. We just hold them and if the PPS then drops to the 50% retrace you speak of, our $5/PUTS will become very attractive indeed! We could ten sell them later if we wish to make a few more dollars.

So I go back to my original thought. We sell the PUT spread to buy CALLS at no expense to us! If we are right and the PPS goes up, we are in the driver's seat to make a lot of money without having to touch a penny of our capital to do so!

Hope this helps.