Sunday, January 18, 2009 6:12 PM
We had another very exciting (and informative) session this past Saturday?.we had a room full of folks looking to learn more about Option Spread trading....this also happened to be the longest meeting yet; -over 5 hours of discussion, review and analysis of Vertical Spread Option strategies??and with only one 10 minute break!!...(my fault?.I promise more breaks next time?)?.it was clear to me everyone came to learn?.not only about options in general, but how to use Option Spread trades to enhance your income. As promised I have attached the general PowerPoint slide deck I used during our discussions (if you are not on my e-mail distribution list you will not recieve this presentation...send me your e-mail and I'll put you on). For those that could not attend I hope to have more on our web sessions shortly.
Below are the Vertical Spread summary highlights we reviewed in greater detail during our Saturday meeting:
1. Vertical Option Spreads can be classified into 4 types:
a. Bull Call Spread (you have both the words ?Bull? and ?Call? in the description you know this is what I call the ?natural? since both words naturally suggest a Bullish trade)
b. Bear Call Spread (you have the word ?Bear? mixed with the word ?Call? you know this is ?not natural? and is a Bearish trade as the name suggest, but using Calls as the trade vehicle)
c. Bear Put Spread (you have the word ?Bear? mixed with the word ?Put? you know this is what I call the ?natural? since both these words naturally suggest a Bearish trade)
d. Bull Put Spread (you have the word ?Bull? mixed with the word ?Put? you know this is ?not natural? and is a Bullish trade as the name suggest, but using Puts as the trade vehicle)
2. Vertical Option Spreads also can be classified as either:
a. Debit Trades (you have to pay to play?.both the naturals [Bull Call Spreads, Bear Put Spreads] are debit trades meaning you will pay money to put on the position (margin not required)
b. Credit Trades (you get paid to play?.both the non naturals [Bear Call Spreads, Bull Put Spreads] are credit trades meaning the market pays you money to put on the position (margin is required)
3. All Vertical Spreads involve 2 legs (one long leg meaning you Buy to Open [BTO] and one short leg meaning you Sell to Open [STO]) in the same month using 2 different strike values in the same ratio of long/short with all Calls or all Puts?putting on a vertical spread gives the trader a natural hedge
4. Since Vertical Spreads give the trader 2 options (no pun intended here) to play either a neutral to bullish; or a neutral to bearish stock bias we reviewed how to select the best way to play them
a. Stock bias is neutral to bullish
i. Bull Call Spread ? it?s the natural so play this if you feel your stock has a solid bullish bias and is a debit trade (you pay to play/no margin required)
1. With a Bull Call Spread we learned your probability of success is not as high as your typical Credit Spread but your returns can go over 300%
2. Ideal timeframe to play this Bull Call Spread is 60-90 days?.give your stock time to breathe so to speak
3. As we reviewed the stock P&L diagram we also discussed how most of your profit in this spread (as in all Vertical Spreads) is not realized until the last 2 weeks of contract expiration?why; -one of the option greeks called theta is working its magic on your short option leg?.
ii. Bull Put Spread ? first you know its not natural (remember your mixing terms Bull and Put) so you know it?s a credit trade which means you get paid to play (margin is required)
1. With a Bull Put Spread we learned your probability of success can be very high (over 90%) but your returns are much lower; - typically in the 5-15% range
2. Ideal timeframe for this Bull Put Spread is 30 days?why; -it?s a credit spread, you?re essentially selling a Vertical Spread so you want the position to expire not giving the stock time to move against you?.
3. Unlike the Bull Call Spread, this trade, the Bull Put Spread as its shown on the P&L diagram the trader will almost always want to hold the position until contract expiration?.
b. Bias is neutral to bearish
i. Bear Put Spread ? again, it?s the natural since you are using the terms, Bear and Put together?it is a debit trade where you pay to play/no margin is required
1. Just like its opposite cousin the Bull Call Spread, this Bear Put Spread has a lower probability of success, but your returns can go over 300%
2. Ideal timeframe to play this Bear Put Spread is 60-90 days?.give your stock time to breathe so to speak
3. As we reviewed the stock P&L diagram we discussed how most of your profits in this spread (as in all Vertical Spreads) is not realized until the last 2 weeks of contract expiration?why; -one of the option greeks called theta is working its magic on your short option leg?.
ii. Bear Call Spread ? it is not a natural since your mixing the terms Bear and Call?this tells you it?s a credit trade which means you get paid to play/margin is required
1. With a Bear Call Spread we learned your probability of success can be very high (over 90%) but your returns are much lower; - typically in the 5-15% range
2. Ideal timeframe for this Bear Call Spread 30 days?why; -it?s a credit spread, your essentially selling a Vertical Spread so you want your position to expire not giving your stock time to move against you?.
3. Unlike the Bear Put Spread, this trade, the Bear Call Spread as it?s shown on the P&L diagram the trader will almost always want to hold the position until contract expiration?.
5. We discussed the importance of strike selection with Vertical Spreads (you have 2 strikes you need to select)?..since its in the same month, after your trade month is selected we discussed the impact and importance of having a wide (strike selections are further apart) or narrow (strike selections are close together) strike selection as well as the strikes in relation to your current stock price
6. So in summary if your bullish or bearish you can play 2 types of Vertical Spreads for each; -one giving you a much higher potential return, but lower probably of success and one that has a higher probability of success but lower returns?..
As you learn more about options having a solid exposure to many of these types of option strategies you may find yourself specializing in just a few to suit your trading risk tolerance and profile?
For your reference, below is our upcoming schedule from Feb thru Jun??.
Feb 28th ? Time Spreads; Calendars and Diagonals
Mar 21st ? Winged Spreads; Butterfly?s and Condors including the Irons
Apr 18th ? Straddles, Strangles and Ratio Spreads
May 16th ? Synthetics
Jun 20th ? Putting it all together
I look forward to seeing you again?..if any of you have any other ideas or suggestions to improve upon our meetings then please send me a note?.