How a Put Spread Works

-- Buy 10 puts on the Dow that expire in March exercisable at 8000 for a cost of $3,000, plus commissions ($300 per put times 10).

-- Sell the 10 puts on the Dow exercisable at 7600 for $2,000 ($200 for each put times 10). The cost to the investor comes down from $3,000 to $1,000, plus commissions.

-- Suppose the market tanks to 7,000 by March. Each put is worth $1,000 and $10,000 for the total.

-- At the same time, the 7600 puts are worth $6,000 and the investor must pay the put buyer that money. So the investor ends up with $4,000. It cost him $1,000, so he nets $3,000.

-- If the market were to fall to 6000, all this investor can make is still the same $3,000, because for every dollar he makes on the put he bought, he loses on the put he sold.

DATA: BUSINESS WEEK