Short Goldman Sachs (GS) with Low Risk

08/25/2011 7:00 am EST

Focus: OPTIONS

If the recent news-driven decline in Goldman Sachs (GS) continues, option traders can employ a specific spread trade strategy that provides limited risk and unlimited profit potential.

Shares of financial behemoth Goldman Sachs (GS) experienced a flurry of selling earlier this week on news that Chief Executive Officer Lloyd Blankfein hired a defense attorney. Traders took the stock down 5% in a mere 15 minutes, displaying fears about what kind of trouble may be coming down the pike for the largest US investment bank. 

While the stock is already down a substantial amount over the past month (the stock was up 0.2% on Tuesday), a put-ratio back-spread strategy offers an interesting risk/reward payoff for those looking for even more selling pressure.

First, let’s look at a daily chart:

chart
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The stock has had a decent past few sessions, but most traders feel like GS still has room to run a bit lower before putting in a bottom.

The back-spread option trading tactic is typically used to capitalize on a large downward move in a stock, but with minimized exposure if the stock stages a surprise move higher. It consists of selling a higher-strike put option while buying multiple lower-strike puts in the same expiration month. 

To enter the spread on GS, traders can sell to open one September 100 put for $5.50 while buying to open two September 90 puts for $3.15 apiece. The net debit for the spread comes to $80, which represents the maximum upside risk if the stock remains above $100 by September expiration. 

Since the spread involves an extra-long put option, it offers unlimited profit potential to the downside. The risk graph below displays the potential risk and reward of the position.

chart
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This trade loses money as time passes, so traders should consider exiting a few weeks prior to expiration in order to avoid time decay in the option’s value.

See video: Trade Options Expiration Like the Pros

By Tyler Craig of TylersTrading.com

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