Great Example of a Long Put Spread

09/29/2011 7:00 am EST

Focus: OPTIONS

Elizabeth Harrow

Financial Analyst, Schaeffer's Investment Research, Inc.

This recent spread trade was executed in order to profit from a downside move in the underlying stock while still limiting risk in the event of a push higher.

Put options were in heavy rotation on Tiffany & Co. (TIF) earlier this week, with 6,270 contracts crossing the tape on Monday alone—representing two-and-a-half times the equity’s average daily put volume. Meanwhile, only about 1,100 calls were exchanged on the upscale jeweler.

Taking a closer look at the day’s major block trades, it looks as though one speculator constructed a long put spread on TIF by purchasing about 2,500 October 65 puts and simultaneously selling an equivalent number of October 55 puts.

The ultimate goal of this bearish debit spread is for TIF to settle at or below $55 upon October expiration. It’s a great example of how a trader can use a spread to limit risk and make money on a downside move.

From a broader perspective, Monday’s accelerated put volume was more of the same for TIF. The stock’s Schaeffer’s put/call open interest ratio (SOIR) stands at 1.31, indicating that puts outnumber calls among options slated to expire within three months. This ratio registers in the 79th percentile of its annual range, suggesting that speculative investors have been more put-heavy only 21% of the time during the past year.

Checking out the charts, TIF has taken a turn for the worse lately. The stock is struggling beneath resistance at its formerly supportive ten- and 20-week moving averages, which have kept a lid on TIF’s progress since early August.

However, the shares remain north of their 80-week moving average, which has alternately served a key role as both support and resistance for years.

chart
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The stock also sits right at the 50-day moving average, and not too far below is the 200-day moving average. Both may act as support, but look out below if both are broken with decent volume.

See related: How to Trade Bull Put Spreads

By Elizabeth Harrow, contributor, Schaeffer’s Trading Floor Blog

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