Risk Control Alert – May 17, 2012

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price.

Risk Control Alert

On all Short Put Options


Tomorrow, May, 18, I have put options expiring in six different names, the Russell 2000 (IWM) $77, the Euro (FXE) $127, Pulte Homes (PHM) $8, Boeing (BA) $72.50, and the Japanese yen (FXY) $121. The May Euro (FXE) $132 calls are also coming off. While your short positions in most of these will expire worthless and book handsome profits, some may not.

Right now Boeing (BA) is the problem, the stock last trading at $71.50 against a $72.50 strike. Those who shorted the puts on a 1:1 basis don’t need to worry. Your gain in the June $70 puts will mostly offset any losses. Those who did the 1:2 ratio that I recommended will take a hit.

Even if you are hedged 1:1, you will still need to take action, because of the mismatch in expirations of your May and June short positions. If the May puts expire in the money you will have Boeing stock placed in your account on Monday at the rate of 100 shares for every put option contract that you are short.

I would recommend selling this immediately at market. It is an inefficient use of capital and you certainly don’t want to fall in love with Boeing stock in these uncertain times. Your risk will be limited to $2.50 per share, because below that you will be fully hedge by the $70 puts which you should still have. The same logic applies to other in the money short put positions.

If you were a professional, I would say trade out of the long stock position in the next rally, or roll down strikes to the next month. But most individuals aren’t that sophisticated, so I would say get out now and cap your risk. If you really don’t want to deal with any of this and want to head off margin calls you can cover your short in the puts today at a loss.

Please note that for us to get into this position the stock market had to drop 11 out of 12 days, one of the longest negative runs in history. There is a better than even chance that we rally on Friday after the Facebook pricing and as traders take profits on shorts ahead of the weekend. All markets are now severely oversold and in desperate need of at least a small bounce before we resume the downtrend.

You also need to look at this in the context P&L of the entire short option strategy. If all the options expire out of the money it will at 10.97%, or $10,970 to the value of your notional $100,000 portfolio. Get half of that and it is still a big win. Not bad for a two week position.

Remember also that the original intention of these trades was to protect the portfolio from the falling volatility and sideways movement that was killing out performance. When you buy fire insurance you don’t complain to the issuer when your house doesn’t burn down. And the only way we can’t in the money was to run up big profits in our existing June puts. That is a nice problem to have.

Please note also that I have correctly called the direction of every single asset class this month, including stocks, bonds, commodities currencies, and the precious metals. All of our losses came from time decay because they moved too slowly. The April 2 top in the stock market is looking like a good one.

In the future I will refrain from the ratios because of the harsh treatment retail individuals get at the hands of margin clerks. All future recommendations will be in the outright options, and in 1:1 spreads where the margin hit is minimal. I will send out profit and loss calculations on every expiring trade on Monday trade.

On to the next trade.