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Today, we touch base with another bearish strategy utilizing put
options. This strategy is also known as buying vertical puts.
By the end of December 6, 2010 trading day, the option chain for
IBM stock for the month of January 2011 should look like the following
table:
|
January
|
2011
|
Option
|
Chain
|
for
|
IBM
|
stock
|
|
|
|
|
IBM
|
149.99
|
-0.39
|
|
|
Put
|
|
|
|
|
|
|
|
Strike
|
Symbol
|
Last
|
Bid
|
Ask
|
Volume
|
Open
Interest
|
|
135
|
IBM012211P135
|
1.04
|
1.03
|
1.06
|
981
|
7513
|
|
140
|
IBM012211P140
|
1.97
|
1.97
|
2.01
|
162
|
4764
|
|
145
|
IBM012211P145
|
3.75
|
3.75
|
3.85
|
184
|
4166
|
|
150
|
IBM012211P150
|
6.65
|
6.65
|
6.75
|
134
|
1263
|
Noticed IBM stock closed at $149.99/share, down $0.39/share for the
day. Let’s say we are bearish about IBM stock and we expect the stock to
retreat. We buy vertical puts for our bearish positions. This strategy
caps our loss and gain. The maximum loss is net debit and the maximum
gain is strike price difference minus net debit. To be profitable in this
strategy, IBM stock has to close below lower strike price and both
options exercised. For simplicity purpose, we use last option price to
determine net debit.
1. Buy 135/140 Puts: Buy 140 put and sell 135 put for a net debit of
$0.93/share.
2. Buy 140/145 Puts: Buy 145 put and sell 140 put for a net debit of
$1.78/share.
3. Buy 145/150 Puts: Buy 150 put and sell 145 put for a net debit of
$2.90/share.
Scenario 1: We buy OTM options. This is an aggressive trade. IBM stock
has to close below $135/share for a profitable trade.
Scenario 2: We buy ATM options. IBM stock has to close below 140
for a profitable trade.
Scenario 3: We buy ITM options. IBM stock has to close below 145
for a profitable trade.
Please notice we trade a higher probability for a profitable trade
with lesser profit.
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