| Home | My photos | Forex | My trading | Contacts |
|
|
You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
|
In order to choose the options with the best probability of profitability for a credit spreadbull put and bear call spreadsit is important to balance out five factorsBULL PUT SPREAD A bull put spread is a credit spread created by the purchase of a lower strike put and the sale of a higher strike put using the same number of options and identical expirations. The maximum reward of this strategy is limited to the credit received from the net premiums and occurs when the market closes above the strike price of the short put option. Therefore, this strategy is implemented when you are bullish and expect the market to close above the strike price of the put option sold. The maximum profit of a bull put spread is limited to the net credit received on the trade. The maximum risk is calculated by subtracting the net credit from the difference in strikes and then multiplying this number by 100. The breakeven of a bull put spread is calculated by subtracting the net credit from the higher strike put. Choosing the Options In order to choose the options with the best probability of profitability for a credit spreadbull put and bear call spreadsit is important to balance out five factors: 1. The profit on these strategies depends on the options expiring worth less; therefore, it is best to use options with 45 days or less until expiration to give the underlying stock less time to move into a position where the short put will be assigned and the maximum loss occur. 2. Since the maximum profit is limited to the net credit initially received, keep the net credit high enough to make the trade worthwhile. 3. Keep the short strike at-the-moneytry to avoid selling an in-the money put. 4. The difference between strikes must be small enough so that the maximum risk is low enough to make the trade worthwhile. 5. Make sure the breakeven is within the underlying shares trading range. Bull Put Spread Mechanics Lets say you are bullish on XYZ, currently trading at 44. You expect a move upward for a close above 50 by next month. To initiate a bull put spread, you sell a higher strike XYZ June 50 put at $7.50 and purchase a lower strike XYZ June 45 put at $3. Both strikes are close enough to allow XYZ to reach the projected strike price of 50. Remember, the object of this strategy is to have both options expire worthless and be able to keep the net credit. In this example, the maximum reward is the net credit of 4.50, or $450 per contract. The breakeven occurs when the underlying assets price equals the higher strike price minus the net credit. In this case, the breakeven equals 45.50: (50 - 4.50 = 45.50). This trade makes the maximum profit if XYZ closes at or above 50 at expiration. You get to keep a lesser portion if the trade closes between 45.50 and 50. As long as XYZ closes above the breakeven point of 45.50, you wont lose money. The maximum risk is calculated by subtracting the net credit from the difference between strike prices multiplied by 100. In this trade the maximum risk is $50: (50 - 45) - 4.50 100 = $50. Therefore, if XYZ closes below 45, you lose $50. The risk profile for this bull put spread example is shown in Figure 5.5. The risk profile of a bull put spread slants upward from left to right displaying its bullish bias. If the underlying shares rise to the price of the short put, the trade reaches its maximum profit potential. Conversely, if the price of the underlying stock falls to the strike price of the long put, the maximum limited loss occurs. Always monitor the underlying stock for a reversal or a breakout to avoid the maximum loss. Exiting the Trade To exit a bull put spread, you have to monitor the daily price movement of the underlying stock and the fluctuating options premiums. Although each trade is unique, lets explore what happens to the trade in the example in the following scenarios: XYZ rises above the short strike (50): Let the options expire worthless and keep the maximum credit received when the trade was initiated ($450). XYZ stays above the breakeven (45.50), but does not rise above the short strike (50): The short put is assigned and you are obligated to purchase 100 shares of XYZ from the option holder at $50 a share. You can sell the shares at the current price, which is above the strike price of the long put and incur a small loss that can be offset by the initial credit received. You can also offset the long put by selling it to garner an additional profit. XYZ falls below the breakeven (45.50), but stays above the long strike (45): Once again, the short put is assigned and you are obligated to purchase 100 shares of XYZ from the option holder at $50 a share. You can sell the shares at the current price, which is slightly above the strike price of the long put. In this case, the loss on the shares will not be balanced out by the credit received. Selling the long put may bring in additional money to mitigate some of the loss. XYZ falls below the long strike (45): The short put is assigned and you are obligated to purchase 100 shares of XYZ from the option holder at $50 a share. You can now exercise the long put to sell the shares at $45 each, incurring the maximum loss of $500, which is balanced by the $450 credit received at initiation for a total loss of $50 (plus commissions). Bull Put Spread Case Study A bull put spread is a credit strategy that benefits when the underlying security trades sideways or higher. Stocks often hit support, which sends the stock higher. At these times, using an at-the-money credit spread can bring in profits. A credit spread profits if the stock moves in two of the possible three directions a stock can move. Both a bear call spread and a bull put spread benefit from sideways movement, with the former benefiting from a down move and the latter from an up move. A bull put spread consists of selling a put and buying a lower strike put. The sale of the higher strike put brings in premium, which is larger than the cost of purchasing the lower strike put. What we then have is a Bull Put Spread Strategy: Buy a put at a lower strike price. Sell a put at a higher strike price. Both options must have identical expiration dates. Market Opportunity: Look for a moderately bullish to bullish market where you expect an increase in the price of the underlying asset above the strike price of the put option sold. Maximum Risk: Limited. (Difference in strikes - net credit) 100. Maximum Profit: Limited to the net credit received. Profit is made when the market closes above the strike price of the short put option. This is a credit trade when initiated. Breakeven: Higher put strike price - net credit received. Margin: Required. Amount subject to brokers discretion. limited risk/limited reward strategy. Unlike a debit spread, though, the risk is often higher than the reward while the odds of success are usually very high. On December 11, 2003, shares of Inco Limited (N) formed a bullish formation. The stock closed the session at $34.86, but it looked as if the stock would move higher and use $35 as support. Using this forecast, a bull put credit spread could have been implemented. Since a credit spread benefits from time decay, its usually best to use front month options. However, the December option had just six days left, so we would have used the January options. By selling the January 35 put for 1.65 and buying the January 30 put for 0.35, this bear call spread would have brought in a credit of $1.30 per contract. The risk graph for this trade is shown in Bull Put Spread Case Study Strategy: With the security trading at $34.86 a share on December 12, 2003, sell 5 January 35 puts @ 1.65 and buy 5 January 30 puts @ 0.35 on Inco Limited (N). Market Opportunity: Expect a moderate move higher in the underlying or at least consolidation above $35. Maximum Risk: (Difference in strikes - net credit) 100. In this case, $370: [(35 - 30) - 1.30] 100 or $1,850 for 5 contracts. Maximum Profit: Net credit received. In this case, $650: (5 1.30) 100. Breakeven: Higher strike minus the initial credit per contract. In this case, 33.70: (35 - 1.30). This bullish credit spread would see the maximum profit achieved as long as shares of N were at or above $35 on February 20, which was options expiration. The maximum risk is calculated by subtracting the net credit per contract of $1.30 from the difference between strikes (30 - 25 = 5). Therefore, the maximum risk is $370 per contract [(5 - 1.30) 100 = $370] or $1,850 for five contracts. The breakeven is calculated by subtracting the net credit of 1.30 from the higher strike of 35. Thus, the breakeven for this trade was at $33.70. Once again, lets assume the trade consists of five contracts for a maximum profit of $650. Shares of N did indeed move higher from this point, leaving the trader with the maximum profit of $650. In this example, the trader had to do nothing but watch the options close worthless, leaving the entire credit in the traders account. |
|
|||||||||||||||
Previous Issues
|
| ©2007 Olesia | Home • My photos • Forex • News • My trading • Contacts |