Butterfly Options » Option Strategies

Option Trading: Credit Spread Strategies

admin — Fri, 01 Jan 2010 00:05:47 +0000

A credit spread is a type of vertical spread. It is a trading strategy in which you are buying an option, call or put, at a certain strike price, and simultaneously selling the same type of option at a different strike price of the same month. The sold strike price must have a higher value thus creating a credit at the time the trade is placed. As time goes on the options premium will depreciate, and as long as the price of the stock does not go past the sold strike price at the end of expiration, you keep the full credit. There are two main ways to trade credit spreads – either a low capital risk trade or a high probability trade.
The low capital risk trade consists of making a trade using in the money (ITM) options or at the money (ATM) options to compose the credit spread. For example a stock trading at $55. You are bearish on this stock feeling that it will fall below $50 and stay there. You create a credit spread using calls called a Bear Call Spread. You would sell an ITM $50 call for $5.75 and then buy an ATM $55 call for $2.00 creating a credit for $3.75. The max value of the spread, the difference between strikes, is $5 (55-50), which makes your max risk is $1.25 (5-3.75). This is the low capital risk your are making $3.75 while risking $1.25 which makes for a 300% rate of return. So a high rate of return a low capital risk, what could be wrong with this trade? The probability of success. The stock needs to be below $50 and stay below $50 at the expiration of the options in order to be a successful trade. You need to be correct in your assessment of the direction of the trade.
The high probability trade consists of making a trade using out of the money (OTM) options to compose the credit. Using the same example of a stock trading at $55 that you are bearish, feeling it will fall and stay below $50, we create a different type of credit spread. To create the credit spread, you would sell an OTM $65 Call for $1.10 and buy an OTM $70 Call for $.50 creating a credit of $.60. The max value is still $5 which makes your risk $4.40, much higher than the previous example. This makes for a high capital risk making only $0.60 while risking $4.40 which makes for a 13% rate of return. The difference however is in the probability of the trade being successful. The stock will need to close below $60 at expiration of the options and since it already is below $60 and you feel the stock is weak and will be going lower. The probability of it gaining 10 points or 18% is unlikely in comparison to the previous low capital risk trade in which the stock is at 55 and has to fall 5 points and stay below $50 for the trade to be successful, which makes this credit spread a high probability of success.
Low capital risk but also a low probability of success for the beginner or a higher capital risk with a high probability of success makes for the two choices for the credit spread trader. The choice depends on the traders personality a more involved trader one that really likes to pay close attention to his trade and can make adjustments when necessary may prefer the low capital risk trade. The trader trading part time or is more conservative in their trades one that likes to place a trade and then just monitor it once daily would be more likely to choose the high probability trade. Which type of trader are you?

How Option Trading Profit In Any Market Conditions

admin — Wed, 09 Dec 2009 23:35:30 +0000

All stock market multi millionaires must be able to profit under any kind of market conditions. If you are able to profit only when stock markets go up, then you will find it a gargantuan task to ever have any sustainable success, much less become a stock market millionaire.
Yes! It is possible and easy to profit whether stocks are up, down or sideways using option trading. If the ability to trade all kinds of market conditions is the doorway to becoming a stock market millionaire, then option trading would be the very key.
In this article, I will outline some common ways by which you can profit from all kinds of markets by option trading.
Simple Option Strategies for Up Markets
Buy Call Option – You could buy the same number of equivalent stocks for a fraction of the price using call options and profit when the stock goes up. If the stock should crash, you will lose only the small amount you put towards buying the option instead of the whole amount that you would have put towards buying the stock itself.
Sell Naked Put Option – Instead of buying call options, you could sell short put options thereby pocketing the entire amount you made on selling the put options if the stock should go up.
Bull Call Spread – A bull call spread consists of buying call options at the money and selling short out of the money call options of the same month. The benefit of this strategy is that you profit when the stock goes up and profit also when the stock stays sideways!
Simple Option Strategies for Down Markets
Buy Put Option – Instead of shorting stocks and risking a margin call, you could simply buy a put option. Buying a put option is exactly the same as buying call options except that you profit when the stock goes down instead of up.
Sell Naked Call Option – Instead of buying put options, you could sell short call options thereby pocketing the entire amount you made on selling the put options if the stock should go down.
Bear Put Spread – A bear put spread consists of buying put options at the money and selling short out of the money put options of the same month. The benefit of this strategy is that you profit when the stock goes down and profit also when the stock stays sideways!
Simple Option Strategies for UP or DOWN Markets
Straddle – A straddle consist of buying a call option and a put option at the same strike price on the same stock. This strategy allows you to profit whether the stock moves up or down and is excellent when you are certain that a stock will move greatly soon but isn’t sure which direction that may be.
Strangle – Similar concept to a straddle but buys out of the money call option and put option instead of at the money ones in order to reduce the cost of the position.
Simple Option Strategies for Sideways Markets.
Covered Call – If you are holding on to a stock that is moving sideways, you could collect “rental” out of it by selling the call option of that stock month after month and pocket the whole amount of the sale should the stock remain sideways.
Short Straddle – Instead of buying call options and put options as described above in a Straddle, you would sell short them instead. In this way, you create an option position which profits when the stock remains sideways.
Are you amazed now at how easy it is to profit in any kind of market conditions by option trading? These are only very few of the many more option trading strategies that you can use to your specific portfolio needs. To learn more about what option trading and stock options are for free, please visit http://www.OptionTradingPedia.com .

Credit Option Spreads

admin — Sun, 22 Nov 2009 23:31:48 +0000

What is a credit spread?
Investopedia says… “An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.”
OK I know that is very vague, so lets see if I can do better.
It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the stock does not go past the sold strike price at the end of expiration you will receive a full credit winning trade.
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will increase in price over the next month and you firmly believe that the stock will not go below $50. You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for $.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your account or actually $75 per contract you trade. The risk of the trade or the amount of money per contract you need in your account is $425 per contract. This gives you a return on investment of 17.5% in how ever many days till Feb expiration.
Lets take it out like a real trade – It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or $500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you will lose $2125.
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed, and exactly how much money you will risk then credit option spread trading is for you. Your profit margins will be between 10 and 20% on each trade – on some of the aggressive credit spreads you can make over 50% – and there are techniques for changing your trade if it becomes a losing trade to help you recover some of the loss and in some cases even make it a winning trade again even though you were wrong on the direction of the movement of the stock.