Consistent Monthly Cash Flow Using The Iron Condor Option Trading Strategy

 Option Trading  No Responses »
Nov 262009
 

Iron Condor Spread is the combination of a Bullish Vertical Credit Spread and a Bearish Vertical Credit Spread on the same underlying asset. Depending on how the spreads are constructed, option traders will potentially be able to obtain twice the collect premium over a single spread position. Since there are bullish and bearish spreads involved in the Iron Condor Option Trading Strategy, there is an upper break even and a lower break even point. Profit is realized when the underlying asset remains above the lower break even point or below the upper break even point. In other words, as long as the price of the asset is above your bullish short strike and below the bearish short strike, the option trader will profit from both spreads through time decay. This strategy can be used regularly on a monthly basis to consistently generate a healthy cash flow in your trading business.
Time decay erodes the value of option prices. There are not many option traders who understand the benefit with trading spreads because it simply looks too complicated. Well, it is not.
Iron Condor Spreads is a market neutral strategy that has positive time decay and negative gamma with limited risk. Traders with any level of option trading experience can use this trading approach. Depending on your brokerage expertise and software, these spreads should be available electronically with single click functionality. Some brokers may even provide better leverage when you trade Iron Condor with them.
The IronCondorSpread Newsletter was designed to identify low risk option trading opportunity when an index remains in a narrow trading range during the current expiration cycle. Holding period is always not longer than 60 days.
In trading, the only objective is to make money. As a trader, you should not into big gains or excitement. Constructed correctly, the iron condor spread can be a consistent income generator. Before getting into new positions, you should look for positions that have an extremely high percentage of profitability. If you have the odds of winning in your favor. you will likely be profitable in the long run.
To do so, look specifically for options that have a relatively higher level of volatility. This means to look for positions that are over priced. Establish a trade positions that you believe that the underlying asset will not move to anywhere new your short strike.
To achieve consistent profit, our Iron Condor positions will always have a wide profit range on the underlying asset. So, in the event that the underlying moves up, down or even sideways, you will always profit with time decay. Having a large profit range is important because it will almost certainly guarantee that we will profit consistently and also it does not require us to spend a lot of time to monitor our open positions. We like the idea of trading with little stress and with little work. Our usual profit target for each Iron Condor spread is 13% to 18%. Profit is usually realized within 60 days.
Iron Condor trading is an effective trading strategy because it is a limited risk approach. You will never lose more that you have allocated for each trade. Although it comes with a high probability of winning, losses can be kept low when the trade moves against you. As rare as losing month may be for us, keeping losses low is the key to any successful trading strategy. While making money is important, capital preservation is equally or more important.
The IronCondorSpread Newsletter, http://www.ironcondorspread.com is the premier website in Credit Spread and Iron Condor Spread Option Trading strategy.

 Posted by at 8:41 pm  Tagged with: , , , , ,

Option Trading Tip – Covered Call Cashflow

 Option Trading  No Responses »
Nov 262009
 

Writing Covered Calls is a conservative strategy where you buy a stock that you would like to invest in and then write a call option against that stock.

This is a cash generating strategy that not only offers downside protection that you otherwise wouldn’t enjoy if you just bought the stock, but also gives you the ability to generate a consistent monthly income, for only minutes of your time.

However as with all option trading strategies, there are pitfalls that you will need to avoid if you are to be consistently profitable.

Here are a few tips that may help you write covered calls successfully.

Always check the fundamentals of the underlying stock and make sure that you would be happy to own even if options didn’t exist.

A great resource for viewing fundamental ‘ratings’ for stocks is at http://www.morningstar.com

Don’t enter a Covered Call trade just because the option premium looks attractive. Higher option premiums (10-15% or more) often mean that the stock is more volatile i.e. prone to huge price swings and therefore greater risk.

I personally target the larger, more liquid and stable companies with monthly call option premiums between the 3-6% range.

One of my personal favorites and a stock that I have had considerable success writing covered calls on over the years is Oracle (ORCL).

I’ve also had consistent success with Intel (INTC) and Nokia (NOK). At times the Nasdaq Tracking Unit (QQQQ) is also attractive (a 3% yield is the highest I’ve ever seen it though).

Don’t hold stocks at least 2 days either side of earnings announcements. Much of the time expectations of good and even great earnings are already priced into the stock and should the stock fall short of expectations or even worse disappoint, a virtual bloodbath can follow. I’ve experienced declines of 30-50% in just a few days by holding my covered call stocks over earnings announcements.

Don’t get me wrong, it can also be good time to be a stockholder if the earnings numbers are really great, but I’m a little more conservative and to me it’s just not worth the risk. You can always buy back in afterwards anyway!

Always take a look at stock charts when choosing a stock to write covered calls on. There are 3 general patterns that I look for:

1) A moderate uptrend.

2) A sideways trend.

However the most conservative/safe chart pattern for covered call writing (in my experience) appears after a stock has had a steep sell off and has begun to move sideways for a couple of months.

This is a type of ‘bottoming’ pattern where much of the downside risk has already been ‘sold’ out of the stock.

As covered call writers it’s always important to remember that our risk lies if the stock falls sharply, so we want to do our best to reduce the risk as best we can. This is just one way that I have found to be effective.

If you go to http://www.stockcharts.com and pull up the chart for the QQQQ during the early part of 2003, you’ll see this exact pattern. I successfully wrote covered calls on the QQQQ for about 4 months during this time before I allowed myself to be assigned and moved onto another opportunity.

There you have it. Hopefully these tips help you on your way to consistent profits and monthly cashflow writing covered calls.

Oh, it also goes without saying but I’ll say it anyway, “Don’t put all your eggs in one basket!”

Happy option trading and investing!

 Posted by at 8:41 pm  Tagged with: , ,

What Makes a Good Investment?

 Option Trading  No Responses »
Nov 262009
 

Investing your money for business doesn’t give you assurance of more profit, but it is relatively possible if you take the right business strategic planning. If you lend your profit to a good investment, then you are ahead of success. You should know what a good investment is and how to deal with it. If you fail to do so, then, you might be chasing the victory forever.Investing is like betting all you’ve got in a casino, the only difference is that, you can work your chances. Chances can come in many forms, business management, business planning, and your approach to upcoming conflicts. On top of this, you should be able to pick what kind of investment can shake the rusts of your business.The key to success of business good investment and effective strategy. There are several options where you can invest your money. There is personal investment like health, education, pension and others. Then there is business investment comprised of business management, economics, finance and real estate.You now have a background of what investment is, but the question is, “which one of them makes a good investment?”. A question that is difficult to answer, but should be given a direct attention.In the financial world, good investment is defined as investing to gain profit, small or large investment. The places you are most likely to get this from are stocks, real estate, private equity in companies and any other businesses that aren’t in decline. Good investment is anything that brings you more profit as compared to what you have when you were just starting. It is something that does not require you so much time than you want to. Property investment is a good example. Remember that the reason why you are investing your money is to gain more and not to save. If you don’t gain on your current investment, quit from it and just try saving your money on a piggy bank. This rule should serve as your guidepost to keep you and your business out of any problems.A good investment doesn’t have to come in a long term or greatly lucrative- it just have to expand the money that you had when you were just starting. You shouldn’t deal with get-rich-quick offers because it might cause you trouble.You can ask information from experiences business investors about your how’s and why’s of your investments. They can be a perfect source for advice to clarify everything about your investments.Unwise decisions can ruin you to eternity. An example of bad investment is purchasing of properties overseas. This kind offer is really hard to resist, the most heart-breaking kind of investment. Distance is a great factor that sometimes we tend to forget some practical issues. But everything still depends on you, if you meet their criteria, then the future is clear.Making profit is never easy. It requires certain procedure and dedication before you can get the gold that you’ve been chasing. When investing your money, you must consider if you’ll be picking the investment that is right for you.

 Posted by at 8:41 pm  Tagged with: , , , , ,

5 Ways to Strategize in Forex Options Trading

 Option Trading  No Responses »
Nov 262009
 

One secret of many traders’ success in whatever type of financial trading market is their use of proven methods and strategies. In forex options trading, it is not different. Currency options trading allows for the use of a variety of option strategies, which are employed to engineer a risk profile to the underlying security’s movement.

One of these strategies is called the “butterfly spread”. This allows the trader to earn profit if currency price during the expiry date is close to the middle of the exercise price of the option. It also allows for smaller loses on the part of the trader. Another strategy similar to the butterfly spread is the “iron condor” strategy. This strategy allows for short options to make use of different strikes. This strategy offers a higher possibility of profit alongside a low net credit as compared to the butterfly spread. Another strategy is what traders call the “straddle”. This involves the selling of both a call and a put at the same exercise of option price. Selling a straddle allows for greater profit on the trader’s part if final price is near exercise price. However, it also allows for greater loss if movement is adverse to the trader’s forecasts. Like the straddle, the strategy called “strangle” is also made via a call and put but with different strike price. This in effect decreases the trade’s net debit as well as the possibility of profit. The last and most popular strategy in options trading is the “covered call”. This happens when a trader buys an option or sells a call. This strategy lowers the trader’s risk since his options are covered by other positions. Although the profit is limited, the loss is also controlled.

 Posted by at 2:18 pm  Tagged with: ,

Option Trading Tip – How to Leap Into Option Profits!

 Option Trading  No Responses »
Nov 262009
 

A LEAP (Long-term Equity Anticipation Product) is simply a long-dated option.

LEAP options that don’t expire upto 2 years into the future give the buyer much more time to be right about the future direction of a stock and at the same time offer tremedous leverage.

LEAP option trading has become quite popular in recent years because just like all options, LEAPs only cost a fraction of what it would cost to buy shares in the underlying stock itself, but give you the same amount of control.

As with all options though, time is the enemy (if you are a buyer) and over time options lose their value.

So how can we use LEAPS to speculate on the future direction of a stock (UP or DOWN) and at the same time reduce our risk of losing all our money on them?

Well let me share with you a couple of simple LEAP option trading strategies that have worked well for me over the years in both bull and bear markets…

TIP:

If you believe a stock will go UP over the next 1-2 years, then buy Call option LEAPs on it and at the same time sell the call options (at least one or two strike prices out of the money) that expire in the current month.

If you believe a stock will go DOWN over the next 1-2 years, then buy Put option LEAPs on it and at the same time sell the put options (at least one or two strike prices out of the money) that expire in the current month.

By doing this you will effectively be getting cash back on your investment every single month that you hold your LEAPs.

Over the long-term this will not only offset the time-decay of your LEAPs, but also offer you some downside protection, should the stock go in the opposite direction that you want it to.

This is known as a Calendar Spread and is a much more conservative way of speculating with LEAPs.

Important:

If the stock rises above your sold strike price for your current month Calls or below your sold strike price for your current month Puts, then you risk being assigned/exercised.

You should never allow this to occur because the moment you are assigned you will lose whatever time value is left on your LEAPs.

It is far better to close out the trade for a profit by buying back the sold option and selling your LEAPs for an overall profit or simply holding your LEAPs and then writing (out of the money) options against them for the next month.

 Posted by at 2:18 pm  Tagged with: , ,

Balance of Risk and Reward in Options Trading

 Option Trading  No Responses »
Nov 252009
 

You don’t need to be a trader or an investor to know that the higher the risk, the greater the reward. This concept is true in all aspects of life and business. The more risk you are willing to undertake in life, the more life returns to you. Indeed, risk and reward are directly proportional and often in trading and investment, the more risk your account is exposed to, the greater the return on investment when things work out as planned.
Knowing that risk and reward are proportional makes finding the correct balance of risk and reward extremely important to all kinds of traders; stock traders, futures traders, options traders etc. There is no one solution that works for everyone and the correct balance is decided upon the risk appetite and risk tolerance of the individual trader.
For stock traders, balancing risk and reward primarily involves adjusting the amount of growth stocks and defensive stocks in one’s portfolio. Generally, the more growth or speculative stocks in one’s portfolio, the greater the risk due to greater uncertainty and therefore the higher the gain when things works out as expected. The more defensive stocks in one’s portfolio, the more predictable returns become and therefore the lower the return as these stocks does not generally move a lot. This degree of risk / reward balancing is at best crude compared to the surgically fine degree of balancing you can have in options trading.
Stock options are the most versatile trading instrument in the world right now due to the wide array of options strategies that are employable. Yes, not only can risk and reward be balanced through employing different mix of strategies in your portfolio, there are also different risk and reward profiles achievable by each individual options strategy. There are options strategies that range from making over 1000% profit while risking all your money to options strategies that make a mere 0.01% return while risking nothing as well as every centimeters in between.
As long as you understand what your personal risk appetite and risk tolerance is, you will be able to find an options strategy that suits your needs 100%. Here’s a general outline of the kind of risk reward balance that can be achieved through options trading:
Highest Risk, Highest Reward – OTM Call / Put buying
This is the options strategy that produces the legendary 1000% profit that amazed so many beginners. What those ads did not tell you is that the risk is losing ALL the money that you put into the strategy. This options strategy involves buying out of the money(http://www.optiontradingpedia.com/out_of_the_money_options.htm)call options when you think a stock is going to go up or buying out of the money put options when you think a stock is going to go down. Professionals use this options strategy with only a very small portion of their money in order to place a bet on an uncertain event such as leveraged buyout. Some lucky amateurs use this options strategy with all their money and then become millionaires overnight. The downside of this strategy is the fact that if the stock did not move far enough in the direction you expected it to, you can lose all the money you put into the strategy. That is also why so many beginners break their accounts overnight in options trading.
Various Degrees of Risk and Reward – Options Spreads
There are literally hundreds of possible options spread strategies out there with various degrees of risk and reward for every market condition. There are more aggressive bullish, bearish, neutral and volatile spreads and there are more conservative ones. All of them shares the same logic of higher risk compensated with a higher profit potential.
Lowest Risk, Lowest Reward – Options Arbitrage
Yes, there are literally risk free trading opportunities in options trading which also returns very small, sometimes negligible returns. These are the legendary options arbitrage strategies. Options arbitrage strategies such as conversion/reversal aims to make a fixed return totally risk free through simultaneously buying the underlying and shorting the overpriced synthetic equal or vice versa. The problem with such strategies is that the returns are so low that most of the time, it’s even lower than the commissions you will pay for the trades made. Even if you manage to return a positive return, the return can be as low as 0.01% in percentage terms. That is why arbitrageurs aim to make an absolute return using enormous amounts of money.
With this in mind, the most conservative traders may choose to specialize totally in arbitrage strategies (http://www.optiontradingpedia.com/options_arbitrage.htm) while the most aggressive traders may choose to specialize in leveraged speculation using OTM options. Everyone else would be able to find something to suit your risk appetite in the hundreds of spread possibilities. This degree of flexibility and range of risk/reward possibilities makes stock options the most versatile trading instrument in the world today and why options trading (http://www.optiontradingpedia.com) is so popular these days.

 Posted by at 7:11 pm  Tagged with: , , , , ,

Earn from Home by Investing in Online Options Trading

 Option Trading  No Responses »
Nov 252009
 

One of the easiest ways to start earning at the comforts of your home is to invest in online options trading.  Options trading would be similar to stock trading because buying and selling assets are involved.  However, trading options is more versatile and involves fewer risks if you are a conservative trader.  You can make this type of portfolio investing as a side job to augment your primary income.  But if you find options trading too complicated and risky, then you can simply start an affiliate site and offer Overstock promo code for consumers.   It is easy to start investing in online options trading.  Basically, you have to find a reliable options broker first so you can create a trading account.  When choosing a broker for options trading, you have to make sure that it can provide excellent customer support.  Online options trading would be a little complex for the novice trader so you need all the help and support of your broker to start earning from the market.  The broker should have several channels of communications like telephone support, email and live chat services.  It must also provide regular tutorials and study modules so you can refine your skills in online options trading.  It is also important to carefully scrutinize the trading platform of the broker.  A reliable broker would be able to give different market charts so you can study the movement of the market.  Your broker should be capable of quickly executing your market order and entering it into the market as options contract.  These are the qualities that you need to find in a broker to ensure that your investments in the options market will become profitable.  Of course, the costs of commissions being charged by the broker should also be considered.  Your profit margin at the options market can be affected by the commissions taken by the broker.  You have to understand that online options trading entail some risks.  You can lose a lot from this type of investment if you are not careful with your trades.  On the other hand, options trading can provide huge rewards especially if your open contracts will gain profits.  If you want to avoid risks and want a home business that you can run easily, then you can simply offer Overstock promo code for consumers.  Overstock is an online retail shop that sells discount items.  It issues discount coupons to attract more buyers.  If you become an affiliate, then you can offer Overstock promo code on your website so you can earn commissions from the online retailer giant.  There are many ways how you can earn from the Internet.  Establishing an online business can become very lucrative if you can manage it well.  If you want big rewards, then you can start trading options and earn money from the market.  This may be risky but it also has greater profit potential.  You can also offer Overstock promo code if you want to avoid risks.  Simply build your own site and drive consumers to the Overstock website.

 Posted by at 7:11 pm  Tagged with: , ,

Ukraine provide potential investment opportunities through its crisis – Grab the chance now or wait?

 Option Trading  No Responses »
Nov 252009
 

Invest in Ukraine now as crisis creates good deals.

 

 I will share some reflections on the state of mergers and acquisitions (M&A) market and discussions on the impact of the crisis on the M&A landscape in Ukraine.

The M&A activity in Ukraine during recent years and how is the economic recession affecting M&A activity?

Despite the crisis, 2008 was the best M&A year in Ukraine’s history, both in the value of deals and volume of transactions. The M&A market grew by 20 percent with respect to 2007, with about $9.2 billion worth of deals conducted. In contrast, we see substantially less transactions closed in the first quarter of 2009, compared to the first quarter of last year.

This trend may be reversed later in the year, but could also signal a downtrend for 2009 versus 2008. Experts in the market signal that there are many M&A dialogues ongoing and the necessity to sell or restructure businesses is more pressing because of the crisis environment. The crisis is putting a lot of pressure on some companies. There is expectations amongst financial players that by the end of this year the number of transactions will have an upswing while the average deal value will be lower than 2008.

A crisis can be supportive to a certain category of M&A activity. Before the crisis, mergers and acquisitions were driven by foreign investment into Ukraine, which was seen as a promising emerging market. Now, M&A activity is more focused and may become more domestic driven on distressed companies or companies with liquidity needs but no access to the debt and equity markets. The crisis typically forces the business community to think harder about M&A options as a strategic tool to solve challenges, than a bull market does.

M&A deals ongoing in certain sectors

There are broad M&A activities ongoing now for the aforementioned reasons. In the banking sector we see some activity due to the current recapitalization needs. High levels of leverage are forcing parts of retail sector to restructure. Overall, consumer sectors will remain active for the simple reason that hryvnia devaluation is making most imports unsustainable. Companies with substantial imported goods before the crisis might look to buy domestic production to avoid the currency volatility. The agriculture sector is doing reasonably well due to capital need to meet both domestic but also international needs for products from this sector.

Valuations for Ukrainian assets have plunged

Valuations of assets have clearly taken a beating. The drop is driven by both the global environment and sector specific elements. In the financial sector, for example, valuations have dropped 70 to 80 percent. For consumer companies, it’s probably closer to 30-40 percent. Ukrainian valuations in the middle of 2008 were inflated, probably by as much as 30-35 percent. It was a premium which was not justifiable by the underlying drivers or structure of the Ukrainian economy at that time. Investors as well as financial institutions offering these assets underestimated or ignored the structural weaknesses of the economy, the lack of political unity and weak infrastructure.

Invest or wait?

This is the strategically right time for investment into Ukrainian assets. There are obviously risks but valuations are lower and assets are more available and there is larger competition to get hold of investors money, and this should drive the values down as well. At the same time, the mid-term prospects for Ukraine remain strong. In the near term, valuations will go up, in particular for those companies that will come out of the crisis stronger and especially after the global economy picks up, and when the elections are over. Said this, there is always a need to sort out the bad deals from the good ones. Transparency combined with underlying assets foundation is always good to look for when doing a deal in Ukraine. All too often deals are made on a too weak due diligence of the asset and its operations and ownerships, and fail from this.

Sectors to focus on

As stated above, finance, consumer related businesses and agribusiness are sectors on the top shelf at the moment. Emerging new energy companies would also be a strategically sound investment approach if you are in for the longer haul. Invest in sectors that are less export-oriented and in those companies that are focused domestic. Look at sectors where companies have steady cash flows and low debt levels.

M&A advisers in Ukraine

The Ukrainian M&A advisory market is still immature with not too many serious internationally experienced players in it. In general, there are mainly London-based banks with small operations or no operations in Kyiv and a number of local players with a business model historically built on a brokerage approach. Some few advisor companies have dedicated team based in Ukraine with international market deal experience. These latter ones are more willing to share the transaction risks with investors. This makes it easier to get investors to trust advices given, as the advisors take part of the risk in a deal as well.There is a broad variety of fee structures that are applied, fees are now more linked to the valuations that could be achieved combined with a fixed-fee component.

Do i recommend some advisors, certainly i do, give me a signal and i will share them with you, contact me at sak@ec-ba.com

You can also read more about me at www.ec-ba.com

 

 

 Posted by at 7:11 pm  Tagged with: , , , , , , , , , , , , , , , , , , , , , , , , ,

Fund Managers on the Move and your Strategic Asset Allocation

 Option Trading  No Responses »
Nov 242009
 

Recent research by Citywire, a leading fund research firm, has revealed that the average fund will only retain its fund management team for two-and-a-half-years.

The analysis, which concentrates on UK funds, is the most comprehensive conducted yet and includes 5 years of data.

The survey examined 1,741 funds and found that over the 5 years to the end of August there were 3,440 manager moves.

It was found that managers are more likely to move during times of stock market turmoil, and unsurprisingly they move less when markets are doing well.

Let’s look at some statistics:

- during the 2002/03 bear market, 27% of funds changed hands

- in the year to August 2004 some 23% changed hands

- in 2005 it was 19%

- and 15% in 2006

But what do all these moves mean to you?

If the manager(s) of your investment fund(s) have moved during the last 2 years (and the likelihood is that some will have) you have a number of options:

- leave your money invested where it is

- find out where the fund manager has moved to and transfer your money there (check the details of the fund on offer)

- take a step back and look at whether your money is being invested with a STRATEGIC investment philosophy, as opposed to a TACTICAL approach

The reality (in our experience) is that many investors are following the tactical approach. They hold a number of funds, perhaps with a handful of product providers, and have no real idea where their money is actually invested or which fund managers are in charge anyway.

In fact, one recent client that we dealt with had total investments (Pensions, ISAs, PEPs) of £300,000, spread across 6 providers and 13 funds. Once the overall portfolio was broken down we saw that he had an 89% exposure to equities/shares. When we analysed his attitude to risk it was shown that he would be uncomfortable with more than 55% exposure to equities.

We also calculated that he did not need to take as much equity risk that he was as he was on track to achieve his overall retirement income goals.

What we did in this case was alter his overall portfolio so that:

- his exposure to equities was reduced to 50%

- we created a portfolio that was invested predominantly in low cost asset class institutional funds

- we added a percentage of bond funds to act as an insurance against market falls

- we adopted a ‘buy and hold’ strategy to minimise fund trading costs (if you don’t know what these are you need to find out)

Academic studies show that Strategic Asset Allocation is behind 90% of a portfolio’s return. Ibbotson Associates conducted research that shows that:

- 91.5% of a portolio’s return is due to strategic asset allocation

- 4.6% is due to stock picking

- 1.8% is due to tactical asset allocation (market timing)

And William Bernstein of The Intelligent Asset Allocator said:

“Market timing and security selection are obviously important. The problem is that nobody achieves long-term success in the former, and almost nobody in the latter. Asset allocation is the only factor affecting your investments that you can actually influence”

So why don’t investors folow this path if all the research points this way?

There are a number of reasons:

- ignorance (never heard of it)

- ignorance (heard of it but can’t be bothered)

- greed (I can pick best performing funds and beat the market)

- ego (I know best, don’t tell me what to do)

- conditioning (I don’t want to do something my peers are not)

And no doubt there are many other reasons.

Some in the fund management industry will have you believe that all you have to do is pick a few good funds and you’ll be well on the way to making great returns on your capital.

Of course, this could happen, but all the research points to adopting a DIFFERENT approach. One which you’re probably not aware of right now.

So what can you do?

Simple.

Find out how this alternative approach works. Do your research, just as we have.

The Financial Tips Bottom Line

Think about this for a minute.

As impartial advisers we are able to recommend ANY fund from the thousands available.

What we’ve done though is take a step back (a number of years ago) and look at the alternative investment methods available to our clients. All based around Strategic Asset Allocation.

Maybe it’s time for you to do the same.

ACTION POINT

The reality is that we have yet to meet a new client who understands the importance of asset allocation (and the majority have never heard of it). Just google the term and you’ll see 2.8m results.

The good news is that it’s relatively easy to implement a strategic asset allocation approach with your investments. It’s just a case of knowing which buttons to press to make it happen.

 Posted by at 3:15 pm  Tagged with: , , , , ,

Option Trading: Credit Spread Strategies

 Option Trading  No Responses »
Nov 242009
 

A credit spread is a type of vertical spread. It is a trading strategy in which you are buying an option, call or put, at a certain strike price, and simultaneously selling the same type of option at a different strike price of the same month. The sold strike price must have a higher value thus creating a credit at the time the trade is placed. As time goes on the options premium will depreciate, and as long as the price of the stock does not go past the sold strike price at the end of expiration, you keep the full credit. There are two main ways to trade credit spreads – either a low capital risk trade or a high probability trade.
The low capital risk trade consists of making a trade using in the money (ITM) options or at the money (ATM) options to compose the credit spread. For example a stock trading at $55. You are bearish on this stock feeling that it will fall below $50 and stay there. You create a credit spread using calls called a Bear Call Spread. You would sell an ITM $50 call for $5.75 and then buy an ATM $55 call for $2.00 creating a credit for $3.75. The max value of the spread, the difference between strikes, is $5 (55-50), which makes your max risk is $1.25 (5-3.75). This is the low capital risk your are making $3.75 while risking $1.25 which makes for a 300% rate of return. So a high rate of return a low capital risk, what could be wrong with this trade? The probability of success. The stock needs to be below $50 and stay below $50 at the expiration of the options in order to be a successful trade. You need to be correct in your assessment of the direction of the trade.
The high probability trade consists of making a trade using out of the money (OTM) options to compose the credit. Using the same example of a stock trading at $55 that you are bearish, feeling it will fall and stay below $50, we create a different type of credit spread. To create the credit spread, you would sell an OTM $65 Call for $1.10 and buy an OTM $70 Call for $.50 creating a credit of $.60. The max value is still $5 which makes your risk $4.40, much higher than the previous example. This makes for a high capital risk making only $0.60 while risking $4.40 which makes for a 13% rate of return. The difference however is in the probability of the trade being successful. The stock will need to close below $60 at expiration of the options and since it already is below $60 and you feel the stock is weak and will be going lower. The probability of it gaining 10 points or 18% is unlikely in comparison to the previous low capital risk trade in which the stock is at 55 and has to fall 5 points and stay below $50 for the trade to be successful, which makes this credit spread a high probability of success.
Low capital risk but also a low probability of success for the beginner or a higher capital risk with a high probability of success makes for the two choices for the credit spread trader. The choice depends on the traders personality a more involved trader one that really likes to pay close attention to his trade and can make adjustments when necessary may prefer the low capital risk trade. The trader trading part time or is more conservative in their trades one that likes to place a trade and then just monitor it once daily would be more likely to choose the high probability trade. Which type of trader are you?

 Posted by at 3:07 pm  Tagged with: , , , ,
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