Advantages of Bought Strangle

Posted on March 24th, 2010 admin No Comments
  • It is possible to profit no matter if the share price goes up or down.
  • A strangle has a lower net debit than the bought straddle.
  • A higher profit in percentage terms than a straddle on the same move in the underlying stock, provided that breakeven point has been exceeded.
  • Since both options are out-of-the-money, time decay on the options is not as rapid as they are with the bought straddle.
  • Unlimited profit if the underlying asset continues to move in one direction.
  • Since the trade is non-directional your outlook can be wrong and still profit from this strategy.
  • The maximum loss is limited to the debit paid.
  • If volatility is low at the time of purchase and volatility rises, both options could profit even without an appreciable change in the stock price.
  • Smaller capital outlay to trade strangles than trading the underlying shares.


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Bought Strangle – Max Profit – Max Loss – Breakeven

Posted on March 24th, 2010 admin No Comments

Maximum Profit

Profit is attained when the share price increases or decreases substantially past the break even points. The maximum profit of a strangle is unlimited.

Maximum Loss

The maximum loss is possible if the share price is between the strike prices of the bought call and put option at expiry. This means both the call and the put would expire worthless and the maximum loss would occur. The probability of the maximum loss depends the distance between the strike price of the call option and put option. The closer the exercise prices are the less likely there will be a maximum loss as one of the options should be in-the-money and have intrinsic value. If the exercise prices are further apart time decay will be a major factor and maximum loss is possible.

The maximum loss for a bought strangle or straddle is limited to the net debit paid. The net debit paid is the premium paid for the call options and the premium paid for the put option. Therefore it is possible to lose your initial investment but no more.

Break Even

There are 2 break even points to a straddle. One breakeven point if the underlying asset goes up this is called the upper breakeven point. The other breakeven point if the underlying asset goes down which is the lower breakeven point.

Upper Breakeven Point: Strike Price + Net Debit Paid

Lower Breakeven Point: Strike Price – Net Debit Paid

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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: 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 Strategy

Posted on March 11th, 2010 admin No Comments

A bull put spread is a moderately bullish option strategy that profits when the underlying share price stays still or increases. A bull put spread is similar to a bull call spread. The bull put spread involves simultaneously selling of a put option at a strike price while also buying the same number of put options of the same asset but at a lower strike. A bull put spread is also a technique to selling naked puts but buying lower puts to reduce the maximum loss. Because the bull put spread is a credit spread, you also make money if the underlying asset does not move through time decay. The bull call spread, on the other hand, would not be able to profit if the stock did not move upward beyond its breakeven point.

Maximum Profit

To achieve maximum profit the share price must be above the sold put strike price at expiry. The maximum profit for a bull put spread is the net credit received.

Maximum Loss

If the stock price decreases below the bought put at the expiration date, then the investor has a maximum loss. The maximum loss is the difference between the sold put and bought put strike price less the net credit received.

Break Even

The breakeven is higher than just selling a put; however the maximum loss is reduced significantly. The break even point is the strike price of the sold put minus the net credit received.


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

BHP Bear Call Spread Example

Posted on March 11th, 2010 admin No Comments

BHP Bear Call Spread

Trade

Sell 5 BHP Feb 09 3200 Calls @ 96

Buy 5 BHP Feb 09 3300 Calls @ 68

Net Credit = 28 cents

This trade requires margin requirements.

Maximum Profit

The ideal result is for the share price to stay below the lower strike price of $32.00.

Max Profit = Net premium received

= 96 -68

= 0.28 x 5 contracts

= $1400

Maximum Loss

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

Max Loss = Total spread less Net Premium Paid

= 0.72 * 5 contracts

= $3,600

Breakeven

Lower strike plus net premium received

Breakeven = 32.00 + 0.28

= $32.28

Risk vs. Reward

Risk 28 cents to make 72 cents profit.

Risk vs. Reward = 1: 0.3889

Main Benefits of Strategy

  1. Provides leveraged exposure to a fall 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.

Technical Analysis

  • Downtrend
  • Trade is above resistance
  • Share Price is below short-term moving averages


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: Identifying Trades – The Greeks

Posted on March 9th, 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 bear call spread. The net delta is calculated by the delta of the bought call option minus the delta of the sold call option. The net delta will always be positive. The net delta indicates if the share price decreases quickly what the value of the bear call spread will be worth. For example, if a bear call spread had a net delta of 0.20, and the share price decreased by $1.00, the bear call spread would have decreased by 20 cents.

Vega

The volatility affect on a bear call spread is varied. When looking to enter a bear call spread you look to sell an out-of-the-money call option. The idea is to sell a call which has a relatively high volatility and therefore trading above its theoretical value. The bear call spread can be traded when volatility is high on the call option which allows the spread to be higher above the current share price so the stock would have to increase further before affecting the trade.

Theta

Credit spreads are trades that take advantage of the time decay nature of options. The effect or time decay is a positive for this trade. When the share price is below the sold call if the share price and volatility remain constant this value of the position will reduce and therefore increase your profit. If the stock price is closer to the lower strike price of the sold call, profits generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the bought call, profits generally decrease 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

Bear Call Spread: The Psychology

Posted on March 9th, 2010 admin No Comments

The reasoning behind placing a credit spread is different to placing a debit spread. Bear Call Spreads and Bull Put Spreads are credit spreads. They are not as aggressive cause you do not need the share price to move to far in a certain direction for instance a bear call spread profits if the share price goes sideways or fall whereas the bear put spread requires the share price to fall to a certain level for maximum profit. This strategy profits from time decay.

The expected share price movement is neutral to slightly bearish. Selling a call option out-of-the-money you receive premium if the share price is below the sold call option strike price at expiry the premium received is the profit. The bear call spread just means you buy a call at a higher level then you sold the call to cap your risk and indentify you maximum risk rather than having no protection and potentially unlimited risk for a small percentage credit. The reasons for trading bear call spreads are;

  • Alternative to naked calls (selling calls 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 bearish on the share price due to a resistance level.
  • Consider the bear call spread when you are expecting a small fall in the price of the stock.
  • The trade of with placing a bear call far out of the money is that the stock price can increase in share price slightly, stay flat or fall 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