264 Part Ill: Put Option Strategies 
use some of the proceeds to purchase the October 45 put. The general idea in this 
tactic is to pull one's initial investment out of the market and then to increase the 
number of option contracts held by buying the out-of-the-money option. 
Example: The trader would receive 6 points from the sale of the October 50 put. He 
should take 2 points of this amount and put it back into his pocket, thus covering his 
initial investment. Then he could buy 2 October 45 puts at 2 points each with the 
remaining portion of the proceeds from the sale. He has no risk at expiration with this 
strategy, since he has recovered his initial investment. Moreover, if the underlying 
stock should continue to fall rapidly, he could profit handsomely because he has 
increased the number of put contracts that he holds. 
The fourth choice that the put holder has is to create a spread by selling the 
October 45 put against the October 50 that he currently holds. This would create a 
bear spread, technically. This type of spread is described in more detail later. For the 
time being, it is sufficient to understand what happens to the trader's risks and 
rewards by creating this spread. The sale of the October 45 put brings in 2 points, 
which covers the initial 2-point purchase cost of the October 50 put. Thus, his "cost" 
for this spread is nothing; he has no risk, except for commissions. If the underlying 
stock should rise above 50 by expiration, all the puts would expire worthless. (A put 
expires worthless when the underlying stock is above the striking price at expiration.) 
This would represent the worst case; he would recover nothing from the spread. If 
the stock should be below 45 at expiration, he would realize the maximum potential 
of the spread, which is 5 points. That is, no matter how far XYZ is below 45 at expi­
ration, the October 50 put will be worth 5 points more than the October 45 put, and 
the spread could thus be liquidated for 5 points. His maximum profit potential in the 
spread situation is 5 points. This tactic would be the best one if the underlying stock 
stabilized near 45 until expiration. 
To analyze the fifth strategy that the put holder could use, it is necessary to 
introduce a call option into the picture. 
Example: With XYZ at 45, there is an October 45 call selling for 3 points. The put 
holder could buy this call in order to limit his risk and still retain the potential for 
large future profits. If the trader buys the call, he will have the following position: 
Long l October 50 put C b' d t 5 . t 
l O b 5 all - om me cos : porn s Long cto er 4 c 
The total combined cost of this put and call combination is 5 points - 2 points were 
originally paid for the put, and now 3 points have been paid for the call. No matter 
where the underlying stock is at expiration, this combination will be worth at least 5