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Missed out on TSLA because the premium is too much? Try Call Spreads!  

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Don't let high premiums prevent you from trading

Stocks like $AMZN and $TSLA have high premiums that might be wayyy above your available funds. Or, you might be waiting to execute a current PUT/CALL option and you're low on available funds.

What can you do? Spreads!

Here is a fantastic clip on how spreads work if you prefer watching instead of reading.

Option Spreads

In options trading, an option spread is created by the simultaneous purchase and sale of options of the same class on the same underlying security but with different strike prices and/or expiration dates.

Any spread that is constructed using calls can be referred to as a call spread. Similarly, put spreads are spreads created using put options.

Option buyers can consider using spreads to reduce the net cost of entering a trade. Naked option sellers can use spreads instead to lower margin requirements so as to free up buying power while simultaneously putting a cap on the maximum loss potential.

Vertical, Horizontal & Diagonal Spreads

The three basic classes of spreads are the vertical spread, the horizontal spread and the diagonal spread. They are categorized by the relationships between the strike price and expiration dates of the options involved.

Vertical spreads are constructed using options of the same class, same underlying security, same expiration month, but at different strike prices.

Horizontal or calendar spreads are constructed using options of the same underlying security, same strike prices but with different expiration dates.

Diagonal spreads are created using options of the same underlying security but different strike prices and expiration dates.

Bull Vertical Spreads

Bull vertical spreads are employed when the option trader is bullish on the underlying security and hence, they are designed to profit from a rise in the price of the underlying asset. They can be constructed using calls or puts and are known as bull call spread and bull put spread respectively.

While they have similar risk/reward profiles, the bull call spread is entered on a debit while the bull put spread can be established on a credit. Hence, the bull call spread is also called a vertical debit spread while the bull put spread is sometimes referred to as a vertical credit spread.

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Chris the Miss - Option Tendies Creator. Enjoy the community!

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Posted : 14/07/2020 2:42 pm
J-Dizzle and halfbare liked
halfbare
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Schwab has a great article as well that helps traders understand using this strategy

https://www.schwab.com/resource-center/insights/content/reducing-risk-with-credit-spread-options-strategy-0  

Credit call spreads

A credit call spread can be used in place of an outright sale of uncovered call options.

The sale of an uncovered call option is a bearish trade that can be used when you expect an underlying security or index to move downward. The goal is usually to generate income when the uncovered call option is sold, and then wait until the option expires worthless. When you establish a bearish position using a credit call spread, the premium you pay for the option purchased is lower than the premium you receive from the option sold. As a result, you still generate income when the position is established, but less than you would with an uncovered position.

The mechanics of a credit call spread (a type of vertical spread) are virtually the same as those of a credit put spread, except the profit and loss regions are on opposite sides of the break-even point, as shown below. Let's look at an example.

Credit call spread example:

  • Buy 10 XYZ May 80 calls @ .50
  • Sell 10 XYZ May 75 calls @ 2 for a net credit of 1.50
     

This spread is executed for a net credit of $1,500 (2 points premium received – .50 points premium paid x 10 contracts [100 shares per contract]). As shown in the graph below, you will profit if the market price of XYZ closes below $76.50 at expiration. You will maximize your profit at or below $75. You will lose money if the price of XYZ goes above $76.50, and you could lose up to $3,500 if XYZ closes at $80 or above at expiration.

image

If you had sold the May 75 calls uncovered, you would have initially brought in $2,000 rather than $1,500. However, the trade-off for reduced $500 profit potential is the ability to limit risk significantly. If you had simply sold the May 75 calls uncovered, your loss potential would have been virtually unlimited if XYZ were to rise substantially. In the case of this credit spread, your maximum loss cannot exceed $3,500. This maximum loss is the difference between the strike prices on the two options, minus the amount you were credited when the position was established.

How credit call spreads work

As we did with the credit put spread, let's examine five different price scenarios in light of the chart above to draw a clearer picture of how a credit call spread can work. We'll assume that once this spread is established, it's held until expiration.

  • Scenario 1: The stock rises significantly and closes at $83 on option expiration. If this happens, you will exercise your 80 calls and acquire 1,000 shares of XYZ at a cost of $80,000. At the same time, your short 75 calls will be assigned, and you'll be required to sell 1,000 shares of XYZ for $75,000. The difference between your buy and sell price results in a loss of $5,000. However, you brought in $1,500 when the spread was established, so your net loss is only $3,500. This will be the case at any price above $80. Therefore, this spread is only advantageous over uncovered calls if XYZ rises above $80.50.
  • Scenario 2: The stock rises only slightly and closes at $78 on option expiration. If this happens, you won't exercise your 80 calls, because they're out of the money. However, your short 75 calls will be assigned, and you'll be required to sell short 1,000 shares of XYZ for $75,000. You can then close out your short position by purchasing 1,000 shares of XYZ at the market price of $78, at a cost of $78,000. The difference between your buy and sell price results in a loss of $3,000. However, because you brought in $1,500 when the spread was established, your net loss is only $1,500. Your loss will vary from zero to $3,500 at prices from $76.50 up to $80.
  • Scenario 3: The stock closes at exactly $76.50 on option expiration. If this happens, you won't exercise your 80 calls, because they're out of the money. However, your short 75 calls will be assigned, and you will be required to sell short 1,000 shares of XYZ for $75,000. You can then close out your short position by purchasing 1,000 shares of XYZ at a cost of $76,500. The difference between your buy and sell price results in a loss of $1,500. However, because you brought in $1,500 initially when the spread was established, your net loss is actually zero.
  • Scenario 4: The stock drops only slightly and closes at $76 on option expiration. If this happens, you won't exercise your 80 calls, because they're out of the money. However, your short 75 calls will be assigned, and you'll be required to sell short 1,000 shares of XYZ for $75,000. You can then close out your short position by purchasing 1,000 shares of XYZ at a cost of $76,000. The difference between your buy and sell price results in a loss of $1,000. However, because you brought in $1,500 when the spread was established, you actually have a net gain of $500. This gain will vary from zero to $1,500 at prices from $76.50 down to $75.
  • Scenario 5: The stock drops substantially and closes at $73 on option expiration. If this happens, you won't exercise your 80 calls, because they are out of the money. Your short 75 calls won't be assigned, because they are out of the money as well. In this case, all of the options expire worthless and no stock is bought or sold. However, because you brought in $1,500 when the spread was established, your net gain is the entire $1,500. This maximum profit of $1,500 will occur at all prices below $75.

As you can see from these scenarios, using credit call spreads works to your advantage when you expect the price of XYZ to fall, which would result in a narrowing of the spread price or, ideally, both options expiring worthless.
Before you consider the sale of uncovered calls or puts, consider the amount of risk you may be taking and how that risk could be significantly reduced through the use of credit spreads.

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Posted : 14/07/2020 3:09 pm
J-Dizzle liked
J-Dizzle
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@halfbare I currently have a debit spread on $CHGG for 10/16.  Bought 70c and sold 75c to create the spread.  Just recently learned about this ability.  Although it doesn't reward quick strike price increases, it rewards time and increases.  I use https://www.optionsprofitcalculator.com/ to visualize and understand my risk/reward.  With the volatile market right now but I feel bullish about CHEGG into earnings and into the fall semester as distance learning will continue. 

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Posted : 15/07/2020 12:41 am
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