The Dow has rallied for sometime now only to stall just before reaching all time new highs. With the fundamentals of our domestic economy being what they are, it’s amazing that the Dow has held up as well as it has. This market is very ripe for a sell off and could easily fall a few hundread points over the course of the next few weeks. October is traditionally one of the worst months for the stock market and there is little if anything out there that would make us believe that this year is any different.
Almost every indicator I look at is giving a sell signal at this time and yet small investors continue to chase this market higher. Which is really another indicator that this rally is a set up. If you take a close look at the commitment of traders reports you can clearly see that while the small traders have maintained their long position, Large traders (read hedge funds) have cut their long position in almost half in just one week. If the pros are not betting on a breakout to new highs why should we?
We are more than likely going to see this market form a double top and this trade is simply a way to position ourselves short in the near term while keeping costs and risk defined and low and at the same time we get a huge range that the Dow can fall in that results in a profit for us.
click the chart to enlarge
Buy one October 2006 Dow 115 put and one October Dow 109 put, and at the same time, sell two October 2006 Dow 112 puts for a combined cost and risk of 45 points ($450) or less to open a position.
Max profit assuming a 45 point fill is 255 points ($2550) and occurs at expiration with Dow trading at 11,200. Partial profit occurs with the Dow trading anywhere between 10,945 and 11,455(break even points) which means we have a range of 510 Dow points that we can profit in!
Max risk, before commissions and fees, and assuming a 45 point fill, is $450. This occurs at expiration with Dow trading below 10,900 or above 11,500.
Odom & Frey
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