Bull Put Spread: Advantages and Disadvantages

Posted on March 16th, 2010 admin No Comments

Advantages of Bear Put Spread

  • The loss is limited if the underlying share price falls instead of rises.
  • If the share price fails to stay above the strike price of the sold put option, the profit yield will be greater than just buying call options.
  • Able to profit even when the share price remains completely still.
  • Lower risk than simply writing naked put options as maximum downside is limited by bought put option.

Disadvantages of Bull Put Spread

  • There will be no more profits possible if the underlying asset rises beyond the strike price of the sold put option.
  • Because it is a credit spread, there is a margin requirement in order to place the trade.
  • As long as the sold put options remain in-the-money, there is a possibility of it being assigned. You may then have to purchase the underlying stock to meet the sold put obligation.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bear Put Spread: Bear Put Spread vs. Bought Put Option

Posted on March 5th, 2010 admin No Comments

There are a number of advantaged of implementing the bear put spread instead of buying a put option. A bear put spread has lower risk than strictly buying put options, but limited profit potential. The bear put spread also has a higher breakeven so the share price does not have to fall as far as a bought put option. The advantages of a bear put spread over a bought put is that the strategy reduces time decay and volatility influence on the strategy pricing. This is because we are selling the out-of-the-money options therefore that option benefits from time decay and volatility reducing the opposite characteristic to a bought call option. Bear put spread can be used when volatility is high and buying a put is too expensive as it eliminates the risk of volatility decreasing. Another reason to trade bear puts is that you might have identified a support level; you can sell the out-of-the-money options at that level to reduce the cost and that will be the maximum profit level at expiry. The main benefit to just buying options is large potential profits and a better delta meaning easier to exit the trade earlier. Also if you are expecting volatility to increase significantly a bought positions will improve as a bear put spread would not.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bear Put Spread: Option Pay-Off Diagrams

Posted on March 3rd, 2010 admin No Comments

It is essential to understand the option pay-off diagram for the option strategy you are trading. It allows you to know to determine at what share price you achieve maximum profit, maximum loss and breakeven level at expiry. The bear put spread is made up of a bought put option and a sold put option at a lower strike. When combined it creates a bear put spread. See below for how the bear put option pay-off diagram is constructed. The dotted green line is the sold put and the dashed green line represents the bought put.

Sold Put


Bought Put


Bear Put Spread


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bought Put Option Example:

Posted on February 19th, 2010 admin No Comments

Buy 1 contract CBA May 2500 Put option @ 180 cents

This option gives you the right to sell 1000 CBA shares for $25.00 each, on or before the expiry date in May. If CBA decreases strongly below $25.00 by expiry of the option, you have locked in a higher selling price for the shares.

As the buyer of the option, you have a choice as to whether you want to exercise and sell the 1000 CBA shares or if you just want to sell the option.

For example, if you are right in your assumption, and CBA falls to below $25.00 over this time, you have locked in a higher selling price for the 1000 CBA shares at $25.00. You could elect to exercise your option and sell the shares, receiving the full face value of $25.00 per share plus other fees and transaction costs that might be applicable. Also, the option premium you paid at the start for this option would be deducted from the $25.00 selling price, so the break-even on this trade will be decreased by this amount.

Alternatively, if you decide that you don’t want to sell the shares, perhaps you were interested only in participating in the decrease in CBA’s share price; you could sell the option and profit from the increase in premium.

Worst case scenario, should CBA increase above $25.00 over this time, your option would lose value. If CBA is above $25.00 at expiry, the option would expire worthless. Should you now want to sell the shares, you could sell them at a higher price in the market. Even though the initial premium paid might be lost, the increased sale price of the shares will at least partially offset this.

Trade Summary

 

Exposure 1000 shares

Initial Investment = $1,800

Max Loss = $1,800

Breakeven = $23.20

Max Profit = $23,200

 


To receive ASX Option Recommendations or to learn more about trading options please request the complete Introduction to Options Trading eBook by contacting us on 07 5504 2244 or info@totaloptions.com.au

Bought Put Option

Posted on February 19th, 2010 admin No Comments

A bought put is a long put, which is a bearish or very bearish position. It gives the holder the right, but not the obligation, to sell the underlying asset at a fixed price or amount on or before a specific period of time. The risk for the holder is limited to the premium paid for the option. The reward is unlimited to an underlying price of 0. The Put purchase strategy benefits from a decrease in the price of the underlying asset.

Put purchases are used if you are bearish on the underlying asset. They can be used as an alternative to shorting (or selling) the underlying asset. A bought put can also be used to protect a currently held position with the underlying asset by locking in a selling price (via the strike price).

Buying a put can be used to hedge or protect existing shares. This can be seen as a form of insurance. You can protect your shares at any level but just like insurance the more you pay for the put the higher your protection. So you can work out if you want to risk 5% of your portfolio and hedge out the remaining position. This is the most important role of a bought put as it can be used as a form of protecting capital and is essential to Self Managed Super. This strategy will be discussed later in the course under protected equity. Please contact me in the meantime if you wish to discuss trading this strategy.

Summary:

Market Outlook Bearish
Risk Premium Paid
Potential Reward Limited to strike price less premium paid
Premium Paid at purchase, no margin calls
Time Decay (Theta) Negative
Volatility (Vega) Positive


To receive ASX Option Recommendations or to learn more about trading options please request the complete Introduction to Options Trading eBook by contacting us on 07 5504 2244 or info@totaloptions.com.au