Secret 97 AGGRESSIVE WRITING WITH LIMITED RISK

A powerful play is the INDEX CREDIT SPREAD.

Naked writing has a big advantage over many other plays because

you win almost all the time, but unlimited risks and sometimes

margin requirements are too much for most investors to

handle. In addition, when you write stock options naked, the surprise

volatility puts you at a disadvantage and can bite you badly!

To counter the danger of surprise volatility, you could write

broad-based index options on indexes, such as the S&P 500

Index. Here you don’t have as much surprise volatility because

the index neutralizes the volatility of individual stocks, but writing

such options during the crash of 1987 resulted in financial

disaster for thousands of investors.

There is an alternative that reduces the risk of such plays,

and that is the index credit spread. Since the late 1980’s, I have

been recommending such trades in my newsletter, and these

trades have generated an excellent track record.

Credit spreads limit your risk, greatly reduce your margin

requirements, and, when designed properly, can have a high

probability of profit.

For example, on February 6, 2003, the S&P 100 Index (OEX)

was priced at 423. The following credit spread listed below had a

96% probability of not hitting our set stop loss of 451, thereby,

making a profit of $50 .

1. Sell OEX 460 call at 1

2. Buy OEX 470 call at .5

Credit price was .5 ($50).

Credit spreads do have risk—the distance between the strike

prices of the option you sell and the option you buy. An OEX 460-

470 credit spread has 10 points ($1000) of risk, less your credit.

The wider the spread, the greater the risk.

To defend against the risk, you need to build in some safeguards.

First, you need to set a stop-loss. I always set my stoploss

out-of-the-money and away from the strike price of the

option I am writing. If I am writing the OEX 400 call as part of

the spread, I would set my stop-loss at about 395.

Second, I make sure there is a high probability that the

index price will not hit the stop-loss. If the probability is greater

than 20% of hitting the stop-loss during the life of the option, I

pass. A simulator is used to measure the probability.

Third, I never buck the trend of the market. Never will I

enter put spreads in the teeth of a decline.

Finally, make sure to take profits and close out your position

if the spread narrows and generates a good profit during the

life of the trade. In other words, get out of the hot seat as soon as

possible. Also, exit if the market trend turns against you or if you

get uncomfortable in the position.

A powerful play is the INDEX CREDIT SPREAD.

Naked writing has a big advantage over many other plays because

you win almost all the time, but unlimited risks and sometimes

margin requirements are too much for most investors to

handle. In addition, when you write stock options naked, the surprise

volatility puts you at a disadvantage and can bite you badly!

To counter the danger of surprise volatility, you could write

broad-based index options on indexes, such as the S&P 500

Index. Here you don’t have as much surprise volatility because

the index neutralizes the volatility of individual stocks, but writing

such options during the crash of 1987 resulted in financial

disaster for thousands of investors.

There is an alternative that reduces the risk of such plays,

and that is the index credit spread. Since the late 1980’s, I have

been recommending such trades in my newsletter, and these

trades have generated an excellent track record.

Credit spreads limit your risk, greatly reduce your margin

requirements, and, when designed properly, can have a high

probability of profit.

For example, on February 6, 2003, the S&P 100 Index (OEX)

was priced at 423. The following credit spread listed below had a

96% probability of not hitting our set stop loss of 451, thereby,

making a profit of $50 .

1. Sell OEX 460 call at 1

2. Buy OEX 470 call at .5

Credit price was .5 ($50).

Credit spreads do have risk—the distance between the strike

prices of the option you sell and the option you buy. An OEX 460-

470 credit spread has 10 points ($1000) of risk, less your credit.

The wider the spread, the greater the risk.

To defend against the risk, you need to build in some safeguards.

First, you need to set a stop-loss. I always set my stoploss

out-of-the-money and away from the strike price of the

option I am writing. If I am writing the OEX 400 call as part of

the spread, I would set my stop-loss at about 395.

Second, I make sure there is a high probability that the

index price will not hit the stop-loss. If the probability is greater

than 20% of hitting the stop-loss during the life of the option, I

pass. A simulator is used to measure the probability.

Third, I never buck the trend of the market. Never will I

enter put spreads in the teeth of a decline.

Finally, make sure to take profits and close out your position

if the spread narrows and generates a good profit during the

life of the trade. In other words, get out of the hot seat as soon as

possible. Also, exit if the market trend turns against you or if you

get uncomfortable in the position.