It has nearly been a month since we started our mock trade on Cigna (CI). Since June 3, the S&P 500 ($SPX) is up 1.22 percent, with the Nasdaq ($COMPQ) virtually flat. However, shares of Cigna have fallen from $51.36 to $47.75, a loss of 7 percent. Below is the week-to-week data for this mock trade:

Bear Put Spread
6/3/2003
Cigna (CI) @ 51.36
Buy 1 Oct 50 Put @ 4.40  IV = 39
Sell 1 Oct 40 Put @ 1.20  IV = 46
Initial Debit = 3.20 or $320
Max Risk = $320
Max Reward = $680
Breakeven = 46.80

6/10/2003
Cigna (CI) @ 49.66
1 Oct 50 Put @ 4.60 (bid) IV = 41
1 Oct 40 Put @ 1.20 (ask) IV = 44
Initial Debit = 3.20 or $320
Current Credit to close = 3.40
Profit = $0.20

6/17/2003
Cigna (CI) @ 48.64
1 Oct 50 Put @ 5.10 (bid) IV = 42
1 Oct 40 Put @ 1.60 (ask) IV = 47
Initial Debit = 3.20 or $320
Current Credit to close = 3.50
Profit = $0.30 or $30 per spread

6/24/2003
Cigna (CI) @ 47.75
1 Oct 50 Put @ 5.20 (bid) IV = 39
1 Oct 40 Put @ 1.50 (ask) IV = 45
Initial Debit = 3.20 or $320
Current Credit to close = 3.70
Profit = $0.50 or $50 per spread

What we see from this information is that a bear put spread doesn’t move as quickly as a straight put. However, if the stock were to move away from us, it also wouldn’t lose ground as quickly. We have a price target on this stock near $40, so this is a longer-term play, with our options not expiring until October. In recent market action, stocks have looked tired and the odds of profit taking have increased. Of course, a lot of what happens with the major market indices will depend on what the Fed has to say about the economy on Wednesday.

Cigna shares moved below their 200-day moving average on Monday and this region rejected shares on Tuesday.  A likely occurrence would be for the stock to move lower following this moving average. Using Advanced GET, both the daily and weekly charts show that shares of CI are going to move to the $30 area, but we’ll be satisfied with a move to $40.

Figure 1: Risk Graph of CI Bear Put Spread

So far, implied volatility has remained neutral, but if the stock continues to decline, this could result in higher IV figures. Many traders wonder how a rise in IV helps a spread when we have sold and bought options. However, by looking on Platinum, we see that the Vega for this trade is currently $3.34. This means that for each point increase in IV, our trade will gain $3.34 cents. This might not be a huge advantage, but every dollar helps.

As this trade progresses, we will continue to track it, but feel free to voice concerns or comments on my forum. Below, I have outlined the basic things that are needed to enter a bear put spread strategy.

1. Look for stock that is expected to move lower. 
2. Check the news to see if there is any pertinent news that could affect the trade. 
3. Check to see the stock has options and if there is Open Interest of at least 100. 
4. Check the reward to risk ratio. We are looking for at least a 2-to-1 ratio. If this is not available, check other option combos. 
5. Use options that have at least 45 days of time. For spreads, it is also a good strategy to use LEAPS. 
6. Figure your exit strategy. This includes a profit exit and a loss exit. With the low cost of spreads, traders are often willing to take a total loss. However, a technical exit is a good idea if you are using Advanced GET or some other technical indicator. 
7. When trading more than one contract, we can sell half our contracts at a double and then can hold on for larger profits without any risk. 
8. The idea is to make more profits over the long haul then we lose using this strategy.

Number 8 might seem obvious, but too many traders are unwilling to lose on a trade. We are going to lose and lose often, but this is all right as long as our profits are higher than our losses. Money management is the key to our success in the options game, but this is also a personal decision based on each traders risk tolerance and capital. Regardless, make sure to have exits in mind to take out the emotion if the stock makes a large move.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
Visit Jody's Forum 

To search for previous articles in this series, please click here.

• Email This Article
• View Full HTML
• Digg This
• Delicious
• Subscribe

Recent Articles by Jody Osborne, Optionetics.com

• January 7, 2009
  Economic Watchdog, Jan 7
• January 7, 2009
  Morning Watch, January 7
• January 6, 2009
  Closing Wrap-Up, January 6
• January 6, 2009
  Morning Watch, January 6
• January 5, 2009
  Economic Watchdog, January 5