Secret 101 THE ULTIMATE POWER PLAY: THE SECRET SURROGATE

The best has been left for the last. One of the most powerful

strategies that I use can create a powerful risk-reward picture. It

is a debit Leaps® spread or long term option debit spread. This

strategy can be used for stocks, indexes and futures. The more

expensive nature of long term options allows you to create debit

spreads that have wonderful potential payoffs, sometimes as high

as 1000%.

And if you are fast on the trigger, on more volatile stocks

and futures your probability of making a profit at some time during

the life of the trade can be very high. This spread can also

provide an excellent surrogate for stock or futures and can be a

life saver if the underlying instrument goes the wrong way.

These debit spreads are a way of buying expensive options

that are good value at lower prices. For example, on April 4,

2001, I entered a Cisco spread where I bought the Cisco Jan 03

17.5 call at 4 1/2 and sold the Cisco Jan 03 45 call at 1 for a

spread price of 3.5 when Cisco was 13.7. The spread reduced the

cost of the 17.5 call by 1 point yet only put a limit on my profits

above 45. Altogether, I risked 3.5 (the most you can lose) to make

a potential gain of 24.5, a 700% return if Cisco was above 45.

Here I had the chance of a home run, yet I reduced the cost

of the Cisco 17.5 call by 22%. Also, using a simulator, I found

there was a 80% chance the spread would double in value some

time during the life of the option play.

And that is exactly what happened when Cisco rose to

24.You can’t beat a strategy where you have an 80% chance of a

100% gain and a chance of a home run with a lower priced, limited

risk trade.

Another example is a El Paso Corporation (EP) spread that I

entered on September 23, 2002 when EP was 7.51. Here I :

1. Bought EP Jan 2004 5 call at 4

2. Sold EP Jan 2004 15 call at 1.9

3. Total cost and risk of 2.1

The position is 2.51 points in-the-money—more than the

cost of the spread of 2.1. Your potential maximum profit is 7.9

points, about a 400% return if EP is above 15 at expiration in

January 2004. Our simulator indicated that there was over an 80% chance that the spread would double in value. And again

that is what happened when EP moved to 11.3.

When designing such a trade, the option that you sell to offset

the cost of the option you are buying should be several strike

prices away. Try to design one that has a spread of 10 points or

more between strike prices and shows a maximum profit of at

least 400%.

Also, using a simulator, try to find one that has over an 80%

chance of profiting. Take profits on half of your position if the

spread price doubles in value. Let the rest ride for bigger gains

but with a trailing stop.

The same kind of spread can be created with longer term futures

options.

Why can you create such spreads? Because these are longer

term options. The far-out-of-the-money options that you are

writing will have a lot of premium, and the fact that you have a

lot of time in these trades increases the chance of them paying

off.

Again, such long term debit spreads make excellent surrogates

for stocks. They give you excellent leverage with small

downside risks. They are excellent for stocks where you are afraid

of the downside.

Play some of the spreads on paper, learn how to design

them, and you will have a powerful weapon in your arsenal.

CONCLUSION

These 101 secrets are the trading tactics, strategies and insights

that I have discovered work in the real world! If you use

some of these secrets as you develop skills to trade options, you

will hopefully not pay a high tuition in this school of real life

trading. You will make mistakes along the way, but these secrets

should help you avoid the more painful mistakes.

If you have trouble understanding how to design some of

these trades in the book, read my book, The Complete Option

Player, which makes strategy design much easier and even includes

worksheets to help with that design.

However, before I leave you, I have one last piece of advice to

give you, and it is the theme of the whole book. Before you enter

a trade, make sure you have an EDGE, an advantage over the rest

of the crowd, whether that is an undervalued or overvalued option,

a high probability of profit or a unique risk-reward picture.

Make sure to have a statistical, mathematical or informational

EDGE! This is the major secret to being a successful option

trader. Also, be a maverick! Sell on rallies, buy on dips.

The best has been left for the last. One of the most powerful

strategies that I use can create a powerful risk-reward picture. It

is a debit Leaps® spread or long term option debit spread. This

strategy can be used for stocks, indexes and futures. The more

expensive nature of long term options allows you to create debit

spreads that have wonderful potential payoffs, sometimes as high

as 1000%.

And if you are fast on the trigger, on more volatile stocks

and futures your probability of making a profit at some time during

the life of the trade can be very high. This spread can also

provide an excellent surrogate for stock or futures and can be a

life saver if the underlying instrument goes the wrong way.

These debit spreads are a way of buying expensive options

that are good value at lower prices. For example, on April 4,

2001, I entered a Cisco spread where I bought the Cisco Jan 03

17.5 call at 4 1/2 and sold the Cisco Jan 03 45 call at 1 for a

spread price of 3.5 when Cisco was 13.7. The spread reduced the

cost of the 17.5 call by 1 point yet only put a limit on my profits

above 45. Altogether, I risked 3.5 (the most you can lose) to make

a potential gain of 24.5, a 700% return if Cisco was above 45.

Here I had the chance of a home run, yet I reduced the cost

of the Cisco 17.5 call by 22%. Also, using a simulator, I found

there was a 80% chance the spread would double in value some

time during the life of the option play.

And that is exactly what happened when Cisco rose to

24.You can’t beat a strategy where you have an 80% chance of a

100% gain and a chance of a home run with a lower priced, limited

risk trade.

Another example is a El Paso Corporation (EP) spread that I

entered on September 23, 2002 when EP was 7.51. Here I :

1. Bought EP Jan 2004 5 call at 4

2. Sold EP Jan 2004 15 call at 1.9

3. Total cost and risk of 2.1

The position is 2.51 points in-the-money—more than the

cost of the spread of 2.1. Your potential maximum profit is 7.9

points, about a 400% return if EP is above 15 at expiration in

January 2004. Our simulator indicated that there was over an 80% chance that the spread would double in value. And again

that is what happened when EP moved to 11.3.

When designing such a trade, the option that you sell to offset

the cost of the option you are buying should be several strike

prices away. Try to design one that has a spread of 10 points or

more between strike prices and shows a maximum profit of at

least 400%.

Also, using a simulator, try to find one that has over an 80%

chance of profiting. Take profits on half of your position if the

spread price doubles in value. Let the rest ride for bigger gains

but with a trailing stop.

The same kind of spread can be created with longer term futures

options.

Why can you create such spreads? Because these are longer

term options. The far-out-of-the-money options that you are

writing will have a lot of premium, and the fact that you have a

lot of time in these trades increases the chance of them paying

off.

Again, such long term debit spreads make excellent surrogates

for stocks. They give you excellent leverage with small

downside risks. They are excellent for stocks where you are afraid

of the downside.

Play some of the spreads on paper, learn how to design

them, and you will have a powerful weapon in your arsenal.

CONCLUSION

These 101 secrets are the trading tactics, strategies and insights

that I have discovered work in the real world! If you use

some of these secrets as you develop skills to trade options, you

will hopefully not pay a high tuition in this school of real life

trading. You will make mistakes along the way, but these secrets

should help you avoid the more painful mistakes.

If you have trouble understanding how to design some of

these trades in the book, read my book, The Complete Option

Player, which makes strategy design much easier and even includes

worksheets to help with that design.

However, before I leave you, I have one last piece of advice to

give you, and it is the theme of the whole book. Before you enter

a trade, make sure you have an EDGE, an advantage over the rest

of the crowd, whether that is an undervalued or overvalued option,

a high probability of profit or a unique risk-reward picture.

Make sure to have a statistical, mathematical or informational

EDGE! This is the major secret to being a successful option

trader. Also, be a maverick! Sell on rallies, buy on dips.