The “Instant” Cash Trade

Today I want to share with you one of the easiest ways to pull money out of the market. Imagine being able to make “dividends” whenever you’d like - that’s the best way for me to describe what I am about to show you.

From back in my hedge fund trading days all the way to now, this is one of my go-to ways to consistently profit. It all starts with the underlying asset - the stock.

The beauty of it is that you don’t even have to know where the stock is headed to profit from it, options spreads will give you a profit regardless.

If you’re new to options or intimidated by spreads, fear not. I am going live on March 26th @ 1pm ET to break down spreads piece by piece. Not only will I show you just how simple they can be, but I also will demonstrate LIVE an options credit spread trade. Plain and simple it’s one of the best ways to profit money from the markets, and I would hate for you to not have it in your trading arsenal. Save your seat for my webinar here. Now let’s get back to spreads.

Options spreads are very powerful trading tools if used correctly, especially credit spreads. To execute a credit spread, premium is collected by selling an option that's more expensive than the option being purchased. This means you are making money from the market right off the bat.  

There are two different types of credit spreads, just as in any trade, you can be long a credit spread or you can be short.

A credit spread constructed with puts is commonly referred to as a bull put spread (long).

A credit spread constructed with calls is commonly referred to as a bear call spread (short).

What’s amazing with credit spreads is the fact that if the market goes nowhere, the time decay on the option will work in your favor. So the stock could move 0% but you can still come away with a large chunk of change.

If we anticipate an increase in the stock price, we’ll initiate a bull put spread within 2 to 4 weeks before expiration. Every time we initiate a bull put spread, we have a 67% chance the trade is going to work in our favor.  If the stock trades higher, we make money and if the stock trades sideways, we make money. If the stock trades lower we can “unwind” the position and liquidate the trade for a small loss.

If we anticipate a decline in the stock price, we’ll initiate a bear call spread within two to four weeks before expiration. Every time we initiate a bear call spread, we have a 67% chance the trade is going to work in our favor. If the stock trades lower, we make money and if the stock trades sideways, we make money. If the stock trades higher we can “unwind” the position and liquidate the trade for a small loss.

The ultimate goal when initiating credit spreads is for time to run out so that you can keep as much of the premium that you collected.

 

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Bull Put Spread

The bull put spread is assembled by simultaneously selling a put option that is out of the money and purchasing a further out of the money put option with a lower strike price.

The only benefit of buying the lower strike price put is for the seller to maintain some type of insurance policy or a hedge, in those cases when the underlying asset moves lower unexpectedly and causes the put that was sold to inflate substantially.

By purchasing the lower strike price put option, the seller limits risk on the put option that was sold to the difference between the strike prices of the option that was sold and the option that was purchased.

The maximum profit potential on the bull put spread occurs if the underlying asset stays above or at the strike price of the put option that was sold. The maximum loss on the trade occurs if the underlying asset trades down to or below the strike price of the option that was purchased.

The loss can never exceed the difference between the two strike prices (minus the net premium received) regardless of how much the underlying asset moves lower, since the option that was purchased will always increase in proportion to the option that was sold.

This is assuming both options eventually end up in the money because the underlying asset traded substantially lower after the bull put spread was initiated.

The break even on the bull put spread occurs if the underlying asset trades at expiration below the strike price of the option that was sold by the amount of the net credit received when opening the position.

Example of Bull Put Spread

Boeing Co (BA) stock is trading at $373.13 and over the past few months has been moving higher gradually and you believe that this price action is going to continue over the next several weeks. You sell a put option with a strike price of $365 that expires in 3 weeks for $5.95 and in case BA stock moves lower, you purchase the $362.5 strike price put option for $5.10. The maximum profit that you can earn on this spread is the net premium that was received when the position was initiated, which was $5.95 minus the $5.10 debit that was spent on the $362.5 put for protection.

If BA stock stays above $365.00 till expiration, the spread seller will keep the premium since both options will expire worthless. If on the other hand the underlying asset trades below $365.00; the spread seller will begin losing on the spread.

Maximum loss will occur if BA stock trades at or below $362.50 because at that price level, the call option that you purchased will begin to offset risk created by the $365 call option; in case BA stock continues moving lower below the $362.50 dollar level.

Maximum loss is the difference between the strike price of the option that was purchased and one that was sold minus the net credit received. Therefore, regardless of how low the underlying asset moves prior to the time the option expires, your risk will always be limited to the difference between the two strike prices minus the premium you received when you initiated the trade.

Credit spreads remain some of the most frequently traded options spreads. The risks and rewards are simple to calculate, and your maximum loss is known at the time the spread is initiated.

Bear Call Spread

The bear call spread is assembled by simultaneously selling a call option that is out of the money and purchasing a further out of the money call option with a higher strike price.

The only benefit of buying the higher strike price call is for the seller to maintain some type of insurance policy or a hedge in cases when the underlying asset moves higher unexpectedly and causes the call that was sold to inflate substantially.

By purchasing the higher strike price call option, the seller limits risk on the call option that was sold to the difference between the strike prices of the option that was sold and the option that was purchased.

The maximum profit potential on the bear call spread occurs if the underlying asset stays below or at the strike price of the call option that was sold. The maximum loss on the trade occurs if the underlying asset trades up to or above the strike price of the option that was purchased.

The loss can never exceed the difference between the two strike prices (minus the net premium received) regardless of how much the underlying asset moves higher, since the option that was purchased will always increase in proportion to the option that was sold.

This is assuming that both options eventually end up in the money because the underlying asset traded substantially higher after the bear call spread was initiated.

The break even on the bear call spread occurs if the underlying asset trades at expiration above the strike price of the option that was sold by the amount of the net credit received when opening the position.

 

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Example of Bear Call Spread

Tesla Inc (TSLA) stock is trading at $267.84 and over the past few months has been moving lower gradually and you believe that this price action is going to continue over the next several weeks. You sell a call option with a strike price of $285 that expires in 3 weeks for $6.40 and in case TSLA stock moves higher, you purchase the $287.5 strike price call option for $5.65. The maximum profit that you can make on this spread is the net premium that was received when the position was initiated, which was $6.40 minus the $5.65 debit that was spent on the $287.5 call for protection.

If TSLA stock stays below $285.00 till expiration, the spread seller will keep the premium since both options will expire worthless. If on the other hand the underlying asset trades above $285.00; the spread seller will begin losing on the spread.

Maximum loss will occur if TSLA stock trades at or above $287.50 because at that price level, the call option that you purchased will begin to offset risk created by the $285 call option; in case TSLA stock continues moving higher above the $287.50 dollar level.

Roger Scott

Senior Publisher

​WealthPress

This article is supplied courtesy of WealthPress

 

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