The Spread Trader: Bear Put Spread On Morgan Stanley (MS)
Here we go again…
Investors are once again hitting the sell button in May. It looks like the old Wall Street maxim, ‘Sell in May and go away’ is proving to be true once again.
Just last week, the S&P 500 had a bullish breakout from its April trading range. And the large cap index appeared to be making a run at its recent highs.
But the bullish momentum didn’t last long…
Over the last four trading days, the bears took control of the market. They sent the S&P tumbling 3% lower. And by the end of the week, it was trading well below the bullish breakout level we saw earlier in the week.
Here’s the worst part…
The same stocks that were leading us higher last week were the same stocks leading the selloff lower. For example, financials had been one of the best performing sectors when the S&P 500 was breaking out. But they were among the biggest losers last week when the markets were falling.
Obviously, bumpy trading full of twists and turns and failed breakouts is frustrating for traders to say the least. And the truth is, with the bears now firmly in control, the markets will likely head even lower from here.
The good news is options allow us to profit whether stocks are sinking or soaring. So, let’s look at an options trade that will allow us to profit from further weakness in financial stocks.
The stock I have in my crosshairs is Morgan Stanley (MS).
As you know, Morgan Stanley is an investment bank. And it’s had a rough run over the last two months. It’s down about 25% from over $21 in March to $16 today.
Clearly, this is one financial stock showing weakness.
This looks like a great opportunity to do a bear put spread on MS. This bearish strategy is made by buying one put option and selling another put option at a lower price.
Here’s what to do now…
Buy the MS July 2012 $16 put for $1.27 and sell the MS July 2012 $12 put for $0.24.
Remember, when buying a put spread, the maximum profit is the difference between the strike prices minus the amount paid for the spread.
This trade costs us $103 ($127 – $24) per contract. Our breakeven on the trade is $14.97. If MS is trading at exactly $14.97 on July 20th, we’ll get our $103 back.
We’ve also limited our risk to our initial $103 investment. If MS is trading above $16 on July 20th, we’ll lose $103. But no matter how high MS goes, we can never lose more than our initial investment.
Now for the good part… profits!
Our maximum profit of $297 comes if MS is trading at or below $12 on July 20th.
In other words, we’re risking $103 for a chance to make $297. And according to our tracking system, there’s a 40% chance of this trade making money. That’s a good risk/reward in my book.
Good Investing,
Corey Williams
Category: The Spread Trader
