Bull Put Spread: Trade Example

Posted on March 19th, 2010 admin No Comments

This is a past recommendation on PBL which demonstrates how the bull put spread strategy works in real life.

Trade:

Bull Put Spread

Sell 10 PBL39 Oct 1950 Puts @ 22

Buy 10 PBL36 Oct 1900 Puts @ 12

Net Credit = 10 cents

This trade requires minimal margin requirements.

Maximum Profit

The ideal result is for both options to expire worthless, so that maximum premium is retained from the credit spread.

= Net Premium Received

= Sold Put Premium – Bought Put Premium

= (0.22 – 0.12) x 10 contracts

= $1000

Maximum Loss

This will occur if the share price is below the bought at expiry

= Difference between strike prices less net premium received

= 50 – 10

= 40

= 0.40 x 10 Contracts

= $4000

Breakeven

Upper strike less net premium received

= 19.50 – 0.10

= 19.40

Main Benefits of Strategy

1. Provides leveraged exposure to a rise in the share price

2. Takes advantage of time decay

3. The ideal result is for the options to expire worthless, which means the client will save on brokerage not having to close the position to take a profit.


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

What Strategy to Trade?

Posted on March 18th, 2010 admin No Comments

Bull Call Spread
The primary reason for buying a bull call spread is an expected increase in share price. This is a directional trade and the aim should be a high percentage return. The reason for placing a bull call spread is that the calls are expensive so sell an out-of-the-money call will reduce the cost of the trade. This strategy is suited for break out trades and trading trends.

Bear Put Spread
The main reason for buying a bear put spread is an expected decrease in share price. The aim of the directional is to have a high risk vs. reward ratio. The bear put spread can be traded when buying puts is too expensive due to high volatility and selling an options against the bought puts reduces cost, breakeven, volatility effect and time decay effect. The trade is suited to a share price in a downtrend. This strategy is suited for break out trades and trading trends.

Bear Call Spread
A bear call is traded when you are expecting a sideways share price movement to a slight decrease in share price. The bear call spread is a credit spread and can be traded as a type for income. The risk vs. reward can be set up depending on the aim of the trader whether to have high probability small profits or low probability high returns. This trade is suitable when volatility is high and expected to decrease. The bear call spread is traded to take advantage of time decay.

Bull Put Spread
A bull put spread is best suited for a sideways to upward trending share price. The bull put spread is a credit spread and can be used as an income generating strategy. The bull put spread is best implemented when there is high volatility in the puts your outlook is volatility to decrease. This may be because the share price is just above a major level of support or at the bottom end of a trading range. The bull put strategy is traded to take advantage of time decay.


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

Bull Put Spread vs. Sold Put

Posted on March 18th, 2010 admin No Comments

A number of advantages are evident when trading bull put spreads compared to selling puts (naked puts). A bull put spread has considerable lower risk than just selling a put which has a much larger risk. The bull put spread has a much better risk vs. reward than selling naked puts. Selling puts can have benefits when combined with portfolios that can help produce income and purchase stock below market value. This strategy is detailed in the Income Strategy E-Book and will be available later in the course.


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

Bull Put Spread: Strategy Risks

Posted on March 17th, 2010 admin No Comments

It is important to always be aware of the strategy risks. The primary risk when placing a bull put spread is when the share price decreases past the sold put and an ever greater concern is if the share price decreases below the bought put (protection). Since you receive a premium to enter this trade there is a required margin. This margin can increase to as much as 1.2 times your maximum loss. For example if you were risk $2,000 the cash margin required in the account can increase to $2,400 (2000 *1.2) which includes the premium received. So it is important to know your maximum risk and make sure there are enough funds to cover the worst case scenario.

Another risk inherent with selling options is volatility. When you open the bull put spread you want the volatility to be high so you can sell the put options for as much value as possible. Once the trade is placed you want the volatility to drop off and time decay to kick in. So even if the share price stays still but volatility increases the position may not profit in the short-term. Increased levels in volatility mean to close out it will cost more to buy back the sold put. If the share price decreases below the sold put prior to expiry there is potentially a risk of exercise.

Exercise

The main risk of credit spreads is the risk of being exercised. If the sold put is exercised it means that you are obligated to buy shares at the exercise price of the sold put. This can have a negative impact in terms of you have bought shares you do not own which means you need to sell them back at the lower level and therefore locking in a loss on the share position. If the share price is below the bought put (protection) when exercised then you can sell the put option which will reduce the loss from being exercised. It is still not possible to lose more than the maximum risk before entering the trade. Another disadvantage of being exercised is the brokerage on the share purchase and sale so it is a good idea to try an avoid exercise. To avoid being exercised you need to monitor your position and more importantly the delta on the sold put. If the share price is below the sold put an indication of the likelihood of being exercised can be identified by the delta. If the delta on the sold call is below -0.95 there is a chance being exercised. If the delta is below -0.98 then it is necessary to implement one of your exit strategies.

To avoid exercise there are two options. If you think the share price will keep decreasing you can close the trade for a loss. If you think you view is correct and the share price will rise from this level and want to keep the position you can roll out to the next month. What this means is you can close the positions you have an open the same position for the next month and do this for no cost or a small credit. Therefore if the share price then increases above the sold put by the next month you can still make maximum profit.

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

Bull Put Spread: Trade Analysis – Risk vs. Reward

Posted on March 17th, 2010 admin No Comments

Trade Analysis

Analysing your trade is essential before placing the trade. You need to make sure you have the necessary detail and go through the following checklist:

  1. Stock Selection: Double check your analysis on the stock and make sure your outlook on the share price reflects the bull put spread.
  2. Determine max loss and check that that is suits your risk profile and how much of your trading account you are risking.
  3. Determine premium received when entering trade, most important as it is also your maximum profit.
  4. Make sure you risk vs. reward suits the trading strategy.

Risk vs. Reward

The risk vs. reward will be different for every strategy. Credit spreads have a lower risk reward meaning the maximum profit (reward) is quite low relative to the maximum loss (risk). This trade can be positioned to risk $0.50 to make a $0.50 this is when the bull put spread is traded at-the-money. The trade can be more cautious by selling out-of the money options where you risk $0.80 to make $0.20. Both trades work well at the right time but the first example only requires a 50% success rate to break even while the second example requires an 80% success rate to break even.

Author: Matthew Gartrell

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

Bull Put Spread: Identifying Trades – The Greeks

Posted on March 16th, 2010 admin No Comments

Delta

When identifying trades it is essential to look at the delta of the option legs. In particular it is important to calculate the net delta of the bull put spread. The net delta is calculated by the delta of the sold put option minus the delta of the bought put option. The net delta will always be negative. The net delta indicates if the share price increases quickly what the value of the bull put spread will be worth. For example, if a bull call spread had a net delta of -0.20, and the share price decreased by $1.00, the bull put spread would have decreased by 20 cents. Therefore to close out the position you buy back the position for less than the premium received to enter the trade.

 

Vega

The volatility affect on a bull put spread is positive. When looking to enter a bull put spread you look to sell an out-of-the-money put option. The idea is to sell a put option which has a relatively high volatility and therefore trading above its theoretical value. The bought put even further out-of-the-money and you want to buy this option with low volatility. When entering the trade you want to volatility to be high and decrease throughout the trade.

 

Theta

Credit spreads are set up to take advantage of time decay. The effect of time decay on this strategy varied with the underlying share price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the higher strike price of the sold put, profits generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the lower strike price of the bought put, losses generally increase at a faster rate as time passes.


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

Bull Put Spread: The Psychology

Posted on March 12th, 2010 admin No Comments

The bull put spread strategy is not as aggressive as the bull call spread. The share price for a bull put spread can move down to the sold put level, sideways or upwards to attain maximum profit, whereas the bull call spread requires the share price to increase to a certain level for maximum profit.

The expected share price movement is neutral to slightly bullish. Selling an out-of-the-money put you receive premium if the share price is above the sold put strike price at expiry and the premium received is the profit. The bull put spread just means you buy a put at a lower level then you sold the put to cap your risk and indentify you maximum loss. The reasons for trading bull put spreads are:

  • Alternative to naked puts (selling puts with no protection) as you have a predefined profit and loss and a better risk vs. reward ratio.
  • Share price outlook may be neutral to slight bullish on the share price due to a support level.
  • Consider the bull put spread when you are expecting a limited rise in the price of the stock.
  • An advantage of placing a bull put far out-of-the-money is that the stock price can increase, stay flat or fall slightly to make a profit. So even if you are wrong you can still profit from the trade.
  • This strategy can be used to produce income.


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 Call Spread: Strategy Risks

Posted on March 10th, 2010 admin No Comments

It is important to always be aware of the strategy risks. The primary risk when placing a bear call spread is when the share price increases past the sold call option and an ever greater concern is if the share price increases above the bought call option (protection). Since you receive a premium to enter this trade there is a required margin. This margin can increase to as much as 1.2 times your maximum loss. For example if you were risk $5,000 the cash margin required in the account can increase to $6,000 (5000 *1.2) which includes the premium received. So it is important to know your maximum risk and make sure there are enough funds to cover the worst case scenario.

Another risk inherent with selling options is volatility. When you open the bear call spread you want the volatility to be high so you can sell the call options for as much value as possible. Once the trade is placed you want the volatility to drop off and time decay to kick in. So even if the share price stays still but volatility increases the position may not profit in the short-term. Increased levels in volatility mean to close out it will cost more to buy back the sold call option. If the share price increase above the sold put option prior to expiry there is potentially a risk of exercise.

Exercise

The main risk of credit spreads is the risk of being exercised. If the sold call option is exercised it means that you are obligated to sell shares at the exercise price of the sold call option. This can have a negative impact in terms of you have sold shares you do not own which means you need to buy them back at the higher level and therefore locking in a loss on that position. If the share price is above the bought call option (protection) when exercised then you can sell the call option which will reduce the loss from being exercised. It is still not possible to lose more than the maximum risk before entering the trade. Another disadvantage of being exercised is the brokerage on the share sale and purchase so it is a good idea to try an avoid exercise. To avoid being exercised you need to monitor your position and more importantly the delta of the sold call option. If the share price is above the sold call option an indication of the likelihood of being exercised can be identified by the delta. If the delta on the sold call option is above 0.95 there is a chance being exercised. If the delta is above 0.98 then it is necessary to implement one of your exit strategies.

To avoid exercise there are two options. If you think the share price will keep increasing you can close the trade for a loss. If you think you view is correct and the share price will fall from this level and want to keep the position you can roll out to the next month. What this means is you can close the positions you have an open the same position for the next month and do this for no cost or a small credit. Therefore if the share price then decreases below the sold call by the next month you can still make maximum profit. This options is normally recommended unless your analysis, technical or fundamentals, indicate a change is trend or market conditions.


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 Call Spread: Advantages and Disadvantages

Posted on March 8th, 2010 admin No Comments

Advantages of Bear Call Spread

  • Loss is limited if the underlying financial instrument rises instead of falls.
  • If the underlying instrument fails to drop below the strike price of the out-of-the -money sold call option, the profit yield will be greater than just buying put options.
  • Able to profit even when the underlying asset remains completely still.
  • Lower risk than simply writing naked call options as maximum downside is limited by the bought call option.

Disadvantages of Bear Call Spread

  • There will be no more profits possible if the share price drops beyond the strike price of the sold call option.
  • Because it is a credit spread, there is a margin requirement in order to put on the position.
  • As long as the short call 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 call 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: Woolworths Limited (WOW) Past Recommendation

Posted on March 8th, 2010 admin No Comments

This is a past recommendation that demonstrates how a bear put spread is implemented in real life.

Trade:

Bear Put Spread

Sell 2 WOWB7 Sep 08 2200 Puts @ 55

Buy 2 WOWW3 Sep 08 2550 Puts @ 175

Net Cost = 120 cents

This trade requires no margin requirements.

Maximum Profit

The ideal result is for the share price to fall below the lower strike price of $22.00.

= Difference between strike prices less net premium received

= 3.50 – 1.20

= 2.30 x 2 contracts

= $4,600

Maximum Loss

This will occur if the share price is above the bought at expiry

= Net Premium Paid

= 1.20 * 2 contracts

= $2,400

Breakeven

Higher strike minus net premium received

= 25.50 – 1.20

= $24.30

Main Benefits of Strategy

1. Provides leveraged exposure to a decrease in the share price

2. The ideal result is for the share price to fall below the lower strike price of $22.00.

Risk:

The main risk is for the share price to increase above profitable range ($25.50) and stay there until expiry. If the position expires above the high strike, the position will expire worthless and there will be no exit cost to the trade. If it is below, we will have to exit the trade to avoid being exercised. A change in volatility levels can also have an effect on the profitability before expiry, however the max loss and profit is known at expiry. Contact your adviser for more information.

Technical Analysis

WOW has a large bearish head and shoulders pattern which has taken about a year and a half to develop. These patterns are usually very reliable and the stock has broken below the neck line this morning. The head and shoulders give a price target of $17.00. We are trading a bear put spread out to September which will return around 200% if the stock falls to $22.00 which is realistic considering the price target for this pattern is $17.00. The September position gives just over 3 months for the stock to fall. Due to the break today, the volatility on the out of the money puts options are very high, so this trade is actually been filled for below fair value which of course is in our favour.


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