Creating a Winning Situation During Uncertain times

The benefit that lies in trading Options contracts is the ability to be able to control the potential outcomes by using the contracts in various combinations.

When trading and selling stocks you take on a great deal of risk and liability as you purchase a piece of this company. Options provide us the opportunity to be able to gain on the projected move of a price value before or after the move has already occurred.

Learning this skill will separate the novice investor who only looks for opportunies to buy low and sell high from the individual who is capable of maximizing their return regardless of the current conditions.

With Options trading there are so many various strategies that It can often get confusing on which one to use. Learning just maybe 2-4 types of trades and getting proficient in those would be best before attempting to learn new ones.

Becoming a master in the market will require you to be capable of trading any current market condition in a manner that risk is controlled and the profit target is strategically market ahead.

I have notice personally the greatest mistake that many investors make is not definiing a profit goal. They settle for whatever they get and are quite emotional in regards to how they decide to close out winning trades.

Having a strong anylsis in place will help determine appropriate entry and exit points for your trades. This will seperate your trading from gambling to investing.

Calls and Puts

Initially we have discussed the benefit in being able to profit of the growth of a stock by purchasing a Call for that stock and allowing the price of the stock to rise. As the stock rises in price then our option becomes more valuable allowing us to gain a profit on the growth in price. If you missed that article click here.

Then we took a look at Put options which allow the investor to be able to gain income based on the drop of a stocks price. This is a powerful tool to be able to profit when the market is currently dropping. This is a great way to be able to gain income on stocks that you do not even currently have ownership in. For more details on how to be able to set up a Put option click here for access to a previous article.

Vertical Spreads

Vertical spreads are considered a bit more on the advanced side of options trading as it requires the combination of mulitiple options contracts to be able to creat what is called a spread. Now vertical spreads are just one of the many types of speads that one could trade in the market and they are best used during specfic market conditions. So before trading any particular kind of spreads its important to be sure to understand how each individual option contract works.

Being that they are a combination of both Calls and Puts having an understanding of the potential risks that are involved in each scenario is essential before moving on towards a more complex styled option trade.

A vertical spread involves the buying and selling both of the same type of option set to expire on the same date yet with different strike prices. This kind of trade gets the title of vertical spread based on the expirations being on the same date although the strike prices vary. These orders are primarily sent on the brokers software at the same time as compared to separately.

Fundamentals behind a Vertical Spread

This strategy is primarily used when the investor is expecting very little movement or change in price in the stock . Vertical Spreads can be modified to have a bias in direction. Regardless of the analysis reflecting little change in price creating a spread give the investor the ability to determine certain opportunities for adjustment in the event that the stock begins to move quickly.

Depending on the style of Vertical spread the investor could experience a debit of funds from their account to be able to purchase the spread or even experience a credit as the selling of the spread will result in the investor gaining the contracts premium.

When conducting a vertical spread the sale of an option helps reduce the costs required to purchase the first option. This brings down the initial investment required to be able to enter the trade which in result lowers the risk of the trade. Now just like when any invetment as we add on strategies to be able to minimize the potential risk, this also tends to reduce the potential profits as a direct result.

By reducing the overall risk of this trade it provides for a more attractive entry point as it provides the investors significant potential to be able to gain their return. Keep in mind that this trade strategy is not typically used when the investor believes there will be a major move in the stocks price. This is best used there is expected to be little movement out of the set price range.

Types of Vertical Spreads

When looking to create a spread with a positive bias one would use either a Bull call Spread or a Bull Put Spread. Both of these strategies involve the trader buying the options with the lower strike price and then selling the option with the higher strike price as well. The main element which seperates either the Bull call or Bull put spread is the timing which the income is generated. The Bull Put creates a net credit at the outset of entering the trade while the Bull Call results in a net Debit.

For those like me who tend to trade on the more bearish side of the market the Bear Call and the Bear put spread option provide for great oppotunity to profit on a stock that has little movment yet with a negative sentiment overall.

To give a brief overview on how the options spreads are used in a daily basis I referenced Investopedia. One of the free tools available online to all investors.

Bull call spread: (premiums result in a net debit)

  • Max profit = the spread between the strike prices – net premium paid.
  • Max loss = net premium paid.
  • Breakeven point = Long Call’s strike price + net premium paid.

Bear call spread: (premiums result in a net credit)

  • Max profit = net premium received.
  • Max loss = the spread between the strike prices – net premium received.
  • Breakeven point = Short Call’s strike price + net premium received.

Bull put spread: (premiums result in a net credit)

  • Max profit = net premium received.
  • Max loss = the spread between the strike prices – net premium received.
  • Breakeven point = Short Put’s strike price – net premium received.

Bear put spread: (premiums result in a net debit)

  • Max profit = the spread between the strike prices – net premium paid.
  • Max loss = net premium paid.
  • Breakeven point = Long Put’s strike price – net premium paid.

Moving forward take the time to learn these strategies and see how you can begin practicing using them on a practice account. When ever implementing a new strategy it is always recommended to first test the strategy a few times before gaining confidence and taking it to your live account.

If you plan on becoming a successful investor be open to receiving feedback on your trading. Just like any skill getting constructive feedback can help you see areas of opportunities that you did not notice. Reach out to see if we can find a mentor that will fit best for you in our network of trading professionals.

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