Assume with XYZ Retail Corp. trading at $50, one buys 10 of the December XYZ $50 puts. With more than six weeks remaining until expiration and an implied volatility of 17%, the puts might have a value of $1.15 per contract, meaning the 10 put contracts cost a total of $1,150. If XYZ shares fall to $47 (let's say there was a disappointing weekly sale), the value of the puts would climb to $3.15, giving the 10 long-put position a value of $3,150.
You now have several choices: Sell the puts and pocket the $2,000 profit, or you could buy 1,000 shares of XYZ at $47, locking in a profit of $1,850, which is $115 less than selling out the puts but keeps the position open. Now, if XYZ were to trade a $50 per share, the 1,000 shares of stock could be sold to secure a $3,000 profit on the long stock trade. And you still would own the 10 put options, which -- assuming there are now just three weeks remaining until the December expiration -- would retain an approximate value of 90 cents, or $900 for the 10 contract position. At this point, if you sell out the puts, the net profit would be $2,750, or 37% greater than if you had simply sold out the puts on the initial dip. And remember, you incurred no additional risk when buying the shares against the long put-option position.
Rinse and Repeat for Healthy Scalp
The real attraction is that the process of risk-free short-term trading or "scalping" can be repeated each time the XYZ share price moves below $50. Profitable scalping actually becomes more attractive and requires a smaller price movement in the underlying as the option expiration date approaches. This is a function of the fact that an at-the-money option retains its time premium better than strikes further in or out of the money, and that its options delta is sloped.