Spread Trading, Information and Education

Spread Trading, Option Spread Trading, Bull Call Spread, Call Spread, Bear Call Spread, Put Spread, Bull Put Spread, Bear Put Debit Spread, Spread Option and Option Spread Trading are all forms of Spread Trading that interests the general public.  Below, we will discuss spread trading examples:

 

Many factors affect values in stock market investing.  These stock investing factors help develop an online investing portfolio with limited risk and superior profits!  Spread trading strategies can take advantage of what the market is giving us.

  

Why Spread Trading, Spread Option, or Option Spread Trading?  Let’s look at the Vertical Bull Call Spread and a Bear Put Debit Spread! 

• Investor is in a moderate bull market or bear market stock investing environment.
•  Investor spread trading gives limited profit potential for limited dollar risk.
• Investor wants to reduce the cost of the option spread trading.
• Investor wants reduced exposure to Volatility.
• Investor wants reduced exposure to Time Decay.
• Investor wants profit from increases or decreases in the spread trading value but wants to limit upside or downside risk.

 

Trading vertical Bull Call Spread options and Bear Put Debit Spread options are more complex than covered call, put or call option strategies.  Regardless, spread trading done the right way can allow traders to profit from moderate movement in the stock using less investing capital per spread option contract. FOR SAFETY USE THE VIRTUAL STOCK EXCHANGE.

           
Vertical Bull Call Spread Option Example:

 

FXI is trading @ $41.20 on 9/24/2009 (FTSE/Xinhua China 25 index)

 
Outlook:

 

Market in China indicates a moderate 8%-9% rise to the upper strike price or slightly above strike price.  We are bullish and want to take advantage of volatility and time decay.  The Delta on our at-the-money $41 call option is much greater than that of the out-of-the-money $46 call option.  This will benefit us as time goes on.  We plan to sell this way before expiration at a very good profit.  We are not trying to hit a home run here or we would just buy the call options!

Bull Call Spread Strategy:

 

            Buy 5 Contracts (FXIBO) Feb.-10 $41 Call Options @ $3.63 per contract

                                              (100 shares/contract)

            Sell 5 Contracts (FXIBT) Feb.-10 $46 Call Options @ 1.63 per contract

 

Cost of Spread Option:

 

($3.63x500=$1,815 Debit) – ($1.63x500=$815 Credit) = $1,000.00 Net Debit

                                 (5 Contracts Controls 500 shares)

 

* (Values shown are at time of expiration.  Commissions and trading fees not included.)

 

Stock Per Share	Long $41 Call Option Ex. ((50-41)x500)-$1,815)	Short $46 Call Option Ex. $815-((50-46)x 500)	Put Option Net Profit/ (Loss) (%)
$50	$4,500-$1,815= $2,685.00	$815-$2,000= ($1,185.00)	$1,500.00 (150 % Max Profit)
$46	$2,500-$1,815= $685.00	$815.00 (Premium Credit)	$1,500.00 (150 % Max Profit)
$45	$2,000-$1,815.00= $185.00	$815.00 (Premium Credit)	$1,000.00 (100 % Profit)
$43	$1,000-$1,815= ($815)	$815.00 (Premium Credit)	$0.00 (Breakeven)
$41	($1,815.00) Lost Premium	$815.00 (Premium Credit)	($1,000.00) Max Loss

 

At Expiration:

 

Maximum Profit = (Difference in Strike Prices – Net Debit) x 5 Contracts =

 (($46 - $41) - $2) x 5 (100)) =     $1,500.00 (150 % Profit)

 

Breakeven = Lower Strike Price + Net Debit = $41 + $2 = $43 Share Price

 

Maximum Loss = Net Debit x 5 x 100 = (3.63 – 1.63) x 5 x 100 = $1,000.00

 

In Summary: Purchase Bull Call Spread option if you anticipate a moderate increase in the ETF and have a time frame in mind to realize your forecast.  Risk is limited to the $1,000.00 total premium paid for the Bull Call Spread option.  Profit is theoretically limited to $1,500.00 or 150%.

 

 

Vertical Bear Put Debit Spread Option Example:

 

William Sonoma (WSM) is trading @ $21.07 on 10/12/2009

Outlook:

 

Market indicates a moderate decline to the lower strike or slightly below with poor earnings and low growth.  We are bearish and want to take advantage of volatility and time decay.  The Delta on our in-the-money $22.5 Put is much greater than that of the out-of-the-money $17.5 Put.   We plan to sell this Bear Put Debit Spread way before expiration at a very good profit to limit our risk.

Bear Put Debit Spread, Spread Option Strategy:

 

            Buy 5 Contracts (WSMNX) Feb.-10 $22.5 Puts @ $3.33 per put contract

                                              (100 shares/contract)

            Sell 5 Contracts (WSMNW) Feb.-10 $17.5 Puts @ 1.13 per put contract

 

Cost of Spread Option:

 

($3.33 Debit- $1.13 Credit) x 5 x 100 = $1,100.00 Net Debit

                         (Controls 500 shares)

 

*(Values shown are at time of Expiration.  Commissions and trading fees not included.)

Stock Per Share	Long $22.5 Put Option	Short $17.5 Put Option	Put Option Net Profit/ (Loss) (%)
$25	($1,665.00) Lost Premium	$565.00 (Premium Credit)	($1,100.00) Max Loss
$20.3	$1,100-$1,665= ($565.00)	$565.00 (Premium Credit)	$0.00 (Breakeven)
$20	$1,250-$1,665= ($415.00)	$565.00 (Premium Credit)	$150.00 Profit (13.63 %)
$17.5	$2,500-$1,665= $835.00	$565.00 (Premium Credit)	$1,400.00 Max Profit (127%)
$15	$3,750-$1,665= $2,085.00	$565-$1,250= ($685.00)	$1,400.00 Max Profit (127%)

 

At Expiration:

 

Maximum Profit = (Difference in Strike Prices – Net Debit) x 5 Contracts

 = (($22.5 - $17.5) - $2.2) x 5 (100)) =      $1,400.00 (127 % Profit)

 

Breakeven = Higher Strike Price - Net Debit = $22.5 - $2.2 = $20.3 Share Price

 

Maximum Loss = Net Debit x 5 x 100

= (3.33 Debit – 1.13 Credit) x 5 x 100 = $1,100.00 (Max Risk)

 

In Summary: Purchase the Bear Put Debit Spread or Spread Option if you anticipate a moderate decrease in the stock and have a time frame in mind to realize your forecast.  Risk is limited to the $1,100.00 total premium paid for the Bear Put Debit Spread option.  Profit is theoretically limited to $1,400.00.  This Bear Put Debit Spread option reduces you cost to execute a bear market position but limits your profit potential.