Goldman Sachs was the second symbol on the Beauty Contest Losers list this morning.

Some readers may have noticed an interesting pattern unfolding on the daily chart, and it looks a lot like the one on the S&P 500 Index.

The chart brought to mind three things.

1. Those with directional opinions on the S&P might use GS as a proxy since puts on the index are generally more expensive.
2. People’s perception of risk is asymmetrical: they like to buy a stock and “protect” the long position with out-of-the-money puts, but they would never do the opposite, namely sell short a stock and “protect” the short position with out-of-the-money calls.
3. In-the-money options are generally shunned by retail because they are perceived as expensive. They might be high in price, but we have to keep in mind that there is a lot of intrinsic value there. From my point of view, all out-of-the-money options are expensive since they have no intrinsic value, not to mention that the time premium decays quickly, and if one’s directional view is incorrect, exponentially.

The Setup

GS flashed a PowerTools TradingSystem sell signal on the close yesterday.

Close = $222.10
SystemStop = $233.90

If one is bearish on the near-term outlook based on the chart pattern and wishes to take a directional position on GS, one way to do it is with puts:

Plan A

A trader with a directional opinion looking for “the home run” would be interested in some “cheap” out-of-the-money puts such as the July 210. That, or maybe even the July 200 PUTS, would be their Plan A.

July 210 PUTS = $3.80
1 PUT = $3.80 x 100 = $380.00 plus commission

Plan B

I would use in-the-money puts. The strike price closest to the SystemStop is $230. July 21 is a little over three weeks away, so that is OK. For our example, we will use the last traded price, since the market is closed right now and we do not have access to the latest bid and ask.

July 230 PUTS = $14.50
1 PUT = $14.50 x 100 = $1,450 plus commission

You can take it from here. If we are wrong off the bat and GS shoots straight up from here, we can expect to get 50% of our money back by selling the puts as the stock price approaches the strike price of $230.00. If GS goes down from here, we track the SystemStop and liquidate the puts if GS closes above the blue dot.

But wait, there are some interesting possibilities. What about a bear put spread? People don’t like these because they limit the upside or try to do them with out-of-the-money options, but consider this:

Buy 1 July 230 PUT = 1,450.00 debit
Sell 1 July 210 PUT = 380.00 credit
Cost of Bear Put Spread = $1,070 plus commission

What If?

I think most of you can do the math for the standard outcomes.

The scenario of interest here is this: If GS goes down 5 percent from here and trades at $210 at expiration, the spread that cost $1,070 will return ($230 strike - $210 strike = $20) x 100 = $2,000, less 4 commissions.

The July 210 PUTS would expire worthless while the July 230 PUTS that cost $1,450 would return $2,000, less 2 commissions.