Trading Strategies Profit Making Techniques For Stock_8

Bull Spreads TABLE 15.9 Price 640 645 6477/8 650 655 660 Bull Call Spread Results and Short Call Results Bull spread −27/8 −27/8 0 +21/8 +21/8 +21/8 195 Short call −17/8 −17/8 −17/8 −17/8 −4 −9 or a long put. The net effect is that you have liquidated the bull spread and are now taking a more bearish stance on the market. Your rationale might be that the market was only somewhat bullish at higher levels but has become bearish because of new information or because the UI price broke a key price support level. Look at the bull call spread used in Table 15.3 as an example. Assume the market rallied to 660 the day after you entered the bull spread—the 645 call is now selling for 20, and the 650 is selling at 17. Your choice is between sticking with the bull call spread or liquidating the long 645 call. Table 15.9 shows the results at different price levels for these two strate-gies. Remember that shifting to a short call at this point means that you are starting out with a loss of 27/8. This loss is counted in the results of the short call. Notice that, in this example, you can never make a profit. The effect of going naked short the call is to reduce your loss on the original bull spread by capturing additional time premium if the UI price continues lower. The only way you can make a profit by liquidating the long call is if the premium on the short call is larger than the loss on the original bull spread. Liquidating the short put makes more sense if you originally put on a bull put spread because the long put has much greater profit potential than the short call. The net result is that converting a bull call spread into a short call will rarely make sense, but converting it into a long put can often be an attractive tactic if you are now bearish. C H A P T E R 16 Bear Spreads Strategy Bear Spreads Price Action Bearish Implied Time Volatility Decay Increasing Helps Hurts Profit Gamma Potential Helps Limited Risk Limited STRATEGY A bear spread is a bearish strategy with both limited risk and profit po-tential. It is not as bearish as buying a put or selling a call, but the risk is generally lower than buying a put and is significantly lower than selling a call. A bear spread is either: r Long a high-strike call and short a low-strike call; or Long a high-strike put and short a low-strike put. This is a popular spread because it usually has a low investment, has limited risk, and compares favorably with other bear strategies. Many in-vestors will take the money they would have invested in long puts and buy bear spreads instead. In many cases, they will end up with greater profit potential if the market moves only moderately lower. Figure 16.1 shows an option chart for a bear spread. 197 198 OPTION STRATEGIES 3 2 1 0 −1 −2 −3 FIGURE 16.1 Price of Underlying Instrument Bear Spread Note the caveat of being only moderately bearish. Bear spreads are a good strategy if you are moderately bearish but not if you are very bear-ish because bear spreads have limited down-side potential. You limit your down-side potential when you buy a bear spread. Another use of the bear spread is to enhance the profitability of a long call or put. This requires that you are already in a long-call or long-put position. Inanylongoptiontrade,youmightfindyourselfineitheraprofitableor an unprofitable situation. If you are holding a profitable long position, you can write a lower strike option to create a bear spread and help protect your profits. In effect, you have limited your profit potential, but you have also limited your risk. Note that this strategy works for both puts and calls. However, you will be bullish on the market if you are in a profitable call position, but bearish if you are in a profitable put position. This means that your market attitude must turn 180 degrees if you are to use this technique for calls. For puts, this strategy is a signal that you are less bearish than before you switched to a bear spread. RISK/REWARD Net Investment Required The net investment is the price of the option with the lower strike price minus the price of the call with the higher strike price. This will always be a credit transaction for a bear call spread because the lower strike call Bear Spreads 199 must always be priced lower than the higher strike call. It will always be a debit transaction for bear put spreads because the higher strike puts must always be priced higher than the lower strike puts. Look at an example. The Major Market Index (MMI) closes at 650.30, the November 645 call is priced at 103/4, and the November 650 call is priced at 77/8. Your net investment will be a credit of the difference be-tween the costs of the two options. In this case, you will receive 103/4 mi-nus 77/8, or 27/8. At the same time, the November 645 put is trading at 7, and the November 650 is trading at 91/8. Here, the trade would be initiated at a net debit of 21/8. Maximum Return The maximum return is limited for a bear spread. You will receive the max-imum return if the underlying instrument (UI) is trading below the lower of the two strike prices when the options expire. The maximum profit potential for a bear put spread is equal to the higher strike price minus the lower strike price minus the net investment. The maximum profit potential for a bear call spread is the net credit re-ceived when the trade is initiated. Assume you initiated the bear put spread by selling the November 645 put at 7 and buying the November 650 put at 91/8 when the MMI was trading at 350.50. You will receive the maximum profit of 27/8 if the MMI is below the lower of the two strike prices, in this case, 645. Table 16.1 shows the profit and loss for each of the two options and the net profit or loss for the total position at different prices of the MMI when it expires. Another column can be added to this table so you can see the differ-ence between this strategy and the outright purchase of a put. In this case, assume you bought the November 650 put at 91/8. Table 16.2 shows that TABLE 16.1 Bear Put Spread Results Profit/Loss MMI price 645 put 650 put 630 −8 +107/8 635 −3 +57/8 640 +2 +7/8 645 +7 −41/8 6477/8 +7 −7 650 +7 −91/8 655 +7 −91/8 Net profit/loss +27/8 +27/8 +27/8 +27/8 0 −21/8 −21/8 ... - tailieumienphi.vn