I bought Aug3011 $81 strike puts on IWM for $5.81, then sold twice as many Aug2011 $72 puts on IWM for $2.93. That is, I bought the right to sell IWM for $81, and sold my promise to buy twice as much IWM for $72. The two dollar amounts cancel one another; this position was started as a hedge against a drop in IWM.
IWM is the Russell 2000 index. It was at $82 when I made this trade.
So, if IWM declines $10 per share (12%) I will be obliged to buy it at $72. At that point, the $81 puts I bought will be profitable.
If IWM rises above $81, the puts I bought will be worthless--but they would cost me nothing because the purchase of the $81 puts for $5.81 would be covered by the puts I sold for $5.86 (2 * $2.93).
If IWM ends between $81 and $72, the puts I sold will expire unexercised. The puts I bought will have a value which will vary according to the market price.
Keep in mind that I'm on the hook to buy IWM at $72. I initiated this position only because I'm willing to own this amount of IWM at this price. The purchase would also be subsidized by the value of the $81 puts I bought (if IWM drops enough that the $72 puts are exercised by the buyer, I will be able to sell half as many shares at $81 due to the puts I bought).
