best siding vinyl siding installation siding installation glencoe install vinyl siding vinyl siding cost .. Chicago Drug testing

Option Spread Trading

Spread trading is a technique that can be used to profit in bullish, neutral or bearish conditions. It basically functions to limit risk at the cost of limiting profit as well.

Spread trading is defined as opening a position by buying and selling the same type of option (ie. Call or Put) at the same time. For example, if you buy a call option for stock XYZ, and sell another call option for XYZ, you are in fact spread trading.

By buying one option and selling another, you limit your risk, since you know the exact difference in either the expiration date or strike price (or both) between the two options. This difference is known as the spread, hence the name of this spread treading technique.

VERTICAL SPREADS

A Vertical Spread is a spread where the 2 options (the one you bought, and the one you sold) have the same expiration date, but differ only in strike price. For example, if you bought a $60 June Call option and sold a $70 June Call option, you have created a Vertical Spread.

Let's assume we have a stock XYZ that's currently priced at $50. We think the stock will rise. However, we don't think the rise will be substantial, maybe just a movement of $5.

We then initiate a Vertical Spread on this stock. We Buy a $50 Call option, and Sell a $55 Call option. Let's assume that the $50 Call has a premium of $1 (since it's just In-The-Money), and the $55 Call has a premium of $0.25 (since it's $5 Out-Of-The-Money).

So we pay $1 for the $50 Call, and earn $0.25 off the $55 Call, giving us a total cost of $0.75.

Two things can happen. The stock can either rise, as predicted, or drop below the current price. Let's look at the 2 scenarios:

Scenario 1: The price has dropped to $45. We have made a mistake and predicted the wrong price movement. However, since both Calls are Out-Of-The-Money and will expire worthless, we don't have to do anything to Close the Position. Our loss would be the $0.75 we spent on this spread trading exercise.

Scenario 2: The price has risen to $55. The $50 Call is now $5 In-The-Money and has a premium of $6. The $55 Call is now just In-The-Money and has a premium of $1. We can't just wait till expiration date, because we sold a Call that's not covered by stocks we own (ie. a Naked Call). We therefore need to Close our Position before expiration.

So we need to sell the $50 Call which we bought earlier, and buy back the $55 Call that we sold earlier. So we sell the $50 Call for $6, and buy the $55 Call back for $1. This transaction has earned us $5, resulting in a nett gain of $4.25, taking into account the $0.75 we spent earlier.

What happens if the price of the stock jumps to $60 instead?

Here's where the - limited risk / limited profit - expression comes in. At a current price of $60, the $50 Call would be $10 In-The-Money and would have a premium of $11. The $55 Call would be $5 In-The-Money and would have a premium of $6. Closing the position will still give us $5, and still give us a nett gain of $4.25.

Once both Calls are In-The-Money, our profit will always be limited by the difference between the strike prices of the 2 Calls, minus the amount we paid at the start.

As a general rule, once the stock value goes above the lower Call (the $50 Call in this example), we start to earn profit. And when it goes above the higher Call (the $55 Call in this example), we reach our maximum profit.

So why would we want to perform this Spread?

If we had just done a simple Call option, we would have had to spend the $1 required to buy the $50 Call. In this spread trading exercise, we only had to spend $0.75, hence the - limited risk - expression. So you are risking less, but you will also profit less, since any price movement beyond the higher Call will not earn you any more profit. Hence this strategy is suitable for moderately bullish stocks.

HORIZONTAL SPREADS

We now look a Horizontal Spreads. Horizontal Spreads, otherwise known as Time Spreads or Calendar Spreads, are spreads where the strike prices of the 2 options stay the same, but the expiration dates differ.

To recap: Options have a Time Value associated with them. Generally, as time progresses, an option's premium loses value. In addition, the closer you get to expiration date, the faster the value drops.

This spread takes advantage of this premium decay.

Let's look at an example. Let's say we are now in the middle of June. We decide to perform a Horizontal Spread on a stock. For a particular strike price, let's say the August option has a premium of $4, and the September option has a premium of $4.50.

To initiate a Horizontal Spread, we would Sell the nearer option (in this case August), and buy the further option (in this case September). So we earn $4.00 from the sale and spend $4.50 on the purchase, netting us a $0.50 cost.

Let's fast-forward to the middle of August. The August option is fast approaching its expiration date, and the premium has dropped drastically, say down to $1.50. However, the September option still has another month's room, and the premium is still holding steady at $3.00.

At this point, we would close the spread position. We buy back the August option for $1.50, and sell the September option for $3.00. That gives us a profit of $1.50. When we deduct our initial cost of $0.50, we are left with a profit of $1.00.

That is basically how a Horizontal Spread works. The same technique can be used for Puts as well.

For more information on spread trading, visit: http://www.option-trading-guide.com/spreads.html

Steven is the webmaster of http://www.option-trading-guide.com. If you would like to learn more about Option Trading or Technical Analysis, do visit for various strategies and resources to help your stock market investments.

In The News:

Chart Reading

As an investor you will want to check out any... Read More

A Common Misconception about Stock Prices

I cringe every time I hear a novice investor tell... Read More

Being Wrong Buying Stock is Okay

Being wrong is OK, but let's not carry it to... Read More

Intervention

Intervention. Now don't let that big word scare you. The... Read More

Stock Market Volatility

In my opinion, due to the volatility of stock market... Read More

Stock Trading Success

The ABC's of Stock Trading SuccessStock trading success...why is it... Read More

Stuff

I continually hear from economists, talking heads, other market letter... Read More

Advisory News Letters

Several times each month I am solicited by various market... Read More

Emotional Trading

The single most expensive stock market trades are those made... Read More

Cash

How many people went to a cash position this week?... Read More

How to Pay Less and Get More: Discount Broker vs Professional

How do you invest? What do you really pay? At... Read More

The Exclusive Club of Large Caps

Picture one of those clubs where only the real heavyweights... Read More

Nest Eggs and Omelets

Do you have a nest egg? You know, a place... Read More

Economists #2

Economists know more about how the fragments of society work... Read More

Leverage - Margin Debt

What is leverage?Here is a definition of leverage from an... Read More

Dont Spend Another Dollar on Business Opportunities Until You Read This

With an insecure job market, overworked employees, insufficient retirement savings... Read More

Hedge Funds: the Good, the Bad, and the Ugly

Alfred Winslow Jones started hedge funds in 1949. He was... Read More

Stock Options Trading Strategies - Lean

Professional stock options traders use the term lean to refer... Read More

Starbucks Stock is Up

Starbucks earnings are up again and so is their stock... Read More

What To Buy?

Now that you have some money burning a hole in... Read More

Lemmings Are Gathering

Before they go over the cliff to their destruction these... Read More

Stock Loans

Hedge current portfolio positions and gain access to capital resources... Read More

9 Deadly Trading Mistakes!

The following are a list of nine things you want... Read More

Long-Term Investment In Todays Market?

The stock market is very unstable at this time going... Read More

Diversification

Wall Street's watchword has always been diversification, but what does... Read More

led parking lot led office lighting fixtures Pete's produce ..
led parking lot led office lighting fixtures Pete's produce ..