Why Pay More?

Why pay more to enter an options trade than you have to?

The answer is, of course, "Don't!"

Using option spread strategies is an effective way to reduce both the capital you put up and your risk, and one of my favorites right now is a bear-put spread.

The tactics behind a bear-put spread are easy to understand and to execute. It's an options trading strategy for when you are moderately bearish on a particular company, index or sector. You simply buy one put option and sell another put option against it with the same underlying stock at a lower exercise price.

With the markets suffering an abysmal start to the new year, we successfully used this strategy in my ChangeWave Options Trader service.

While few names are flourishing in this screwball market, few sectors have been hit harder than Big Pharma.

On Jan. 17, things were going pretty badly in the drug stocks, as Merck (MRK) and Schering-Plough (SGP) were hit hard with the ugly stick, falling 6% and 7%, respectively.

---

When it comes to options trading, don't you want to have a pro on your side? Let Jon Najarian walk you through successful trading -- risk-free! Click here to learn more ...

---

Merck was removed from the "Focus 1" list at Merrill Lynch (MER) that morning, which contains the firm's top stocks. And to add insult to injury, a Seattle law firm claimed to have filed a class-action lawsuit against both MRK and SGP, saying they violated state consumer protection laws for the marketing of cholesterol drugs Zetia and Vytorin.

Our proprietary bearish indicator Depth Charge showed some 10,500 MRK Feb 55 Puts trading almost exclusively on the offer price, which is to say they were bought aggressively from the opening price of $1 up to the day's high at $2.05.

1  |  2

next >>

A total of 45,000 puts changed hands in MRK versus a 30-day average daily put trade of 5,500 contracts. The open interest at the $55 strike was 7,200 contracts.

In plain English, the trading activity was bearish, to say the least. The stock was trading in the $58 area, so if investors were buying puts at $55, it means they were making a bet that the stock was going to drop three points before February options expiration came around.

Now, if I had recommended that my Options Trader subscribers go out and buy the MRK Feb 55 Puts, they would have shelled out $2.15 (or $215 per contract).

But there was no need for them to pay full price, so instead I recommended they institute a bear-put spread by purchasing the MRK Feb 55 Puts at $2.15 and selling an equal number of the MRK Feb 50 Puts against them for a 60-cent credit, which lowered their net expenditure to $1.55 per share.

On Jan. 18, MRK was down another 4.5%, and it spelled more ugliness for the drugmaker. Just a few short days later, on Jan. 22, I recommended that my readers close out half of their positions in the MRK Feb 55-50 bear-put spread to preserve our 64% profit in the batty market, but I wanted to keep some on the table just in case there was a pop.

We didn't have to wait too long for the next spike to come around. In fact, it came the next day (Jan. 23). We closed our position for an additional 106% win. Cha-ching!

The spread was up to $3.30 from our $1.55 investment, but even though the drug giant was on its backside, I was worried about an emergency European Central Bank rate cut and what it might do to impact the global market and, specifically, this declining drug stock. So, we bid farewell to the MRK Feb 55-50 bear-put spread, pocketed our overall 85% winnings, and went hunting for fresh meat. Not too shabby for these tough market conditions!

My systems that track unusual options trading activity are always on the prowl, and I'm constantly in search of the next big winner. I'm already hard at work, looking for this week's biggest opportunities -- click here to join my Options Trader service and get positioned for our next trade!

<< previous

1  |   2