Fri Jul 13, 2007: Riding the Breakout with Put Trailers

The stock market broke out to new all-time highs this week. Option writers who want to ride the uptrend while it lasts might consider selling put spreads trailing behind the momentum on some of the most popular stocks, with the idea that winning investors will let their winnings ride, and refuse to sell enough shares of their favorite stocks to cause any serious price drops over the near term.

What are some of the most popular stocks in the market today? Google Inc. (NASDAQ-GOOG, 557.16) and Apple Inc. (NASDAQ-AAPL, 137.13) certainly come to mind. While their lofty stock prices are likely to suffer a big hit at some time in the future, for now the trend is clearly higher and bulls are celebrating. Option writers who want to join the party while the good times last could do so with limited risk by selling put spreads.

Chart of GOOG Stock

Chart of AAPL Stock

Let's look at selling a July put spread on Google, and an August put spread on Apple.

If the price of GOOG stock stays above $530 per share until July 20th (one week from today) you could pocket a 21.2% profit by selling the July 530-520 put spread now.

If the price of AAPL stock stays above $130 per share until August 17th (five weeks from today) you could pocket a 38.9% profit by selling the August 130-125 put spread now.

Remember that these returns exclude commissions and slippage as discussed in previous commentaries.

If the stocks fall below $520 and $125 respectively, you could lose your entire margin deposit, but no more than that. So this is a limited risk way to "chase the bull".

For a more detailed discussion of writing put option spreads including other risks, please refer to this previous commentary: Sell Put Spreads Instead of Covered Calls?

Until next time, best of luck with your option investments!