Bells, whistles, bright colors, the smell of cigarettes lingering off the suits of men. Are we in a Casino or are we standing on Wall Street? Modern technology has made investing look just as exciting and fun as gambling in casino.
Your online broker software probably makes a cool sound when you enter a trade. It probably make an ominous buzzer sound when you close our a loosing trade and rings a bell when you close a winning trade. Why are these programs designed in our trading software today?
A lot of it has to do with manipulating out sense to be more engaged in the event. As we click Buy on the stock and the bell rings through our speaker our brain reacts to the sound just how Pavlov’s dogs were conditioned by bells and sounds.
We feel a sense of euphoria rush through our body and suddenly as our nervous system begins to excite itself by the adrenaline that is released we tend to loose focus. The highten emotion that we are now experiencing can alter our trading strategy. As we experience the rush of endorphins released we start to yearn for the feeling similar to how an addict develops a drug addiction.
This is where many individuals start to crave the interaction with the stock market not for what it has the possibility of providing for an individual but for the rush and excitement it provides them on a personal basis.
The idea that you can open a small $500 trading account and within a few days become a millionaire is over hyped and not probable. Now is it possible yes, certainly. If you enter in extremely over leveraged trades that could potentially cost you the entire account value and you managed to achieve return rates unlike any other human has had record of. But that is not sustainable and realistic.
See, I learned early on to not treat the stock market like a casino. Leave the emotions out of it when trading and learn to develop the skill of generating consistent income. In the next section I am going to go over a strategy called a Debit Spread.
A Debit Spread is an options strategy that you can use with relatively low initial investment that provides you with the opportunity to earn profits on a weekly or monthly basis. This is an short term income generating strategy as it is not designed for long term investing.
Trading Options Spreads
In previous articles we have looked at buying calls and puts to be able to generate income on the movement of a stock. When trading spreads it involves opening multiple options contracts on the same stock.
These orders can be done directly through your online broker just like how you would open the order on one option. The benefit of trading spreads is that we can better mitigate our potential risk or even better define our profit by adding on additional options orders in combination together.
Let’s take a look at what a Bullish Debit Spread involves and lets take a look at an example of how we can use them in the current market. First to break down the title Bullish Debit Spread word by word to better understand the strategy.
Bullish would imply that our outlook is to the upside with this particular stock. Debit would state that we are paying to enter the trade and spread states that this is a combination of two or more options that are being opened.
To open a Bullish Debit Spread you place an order to buy a the call of your choice and then you sell the call that is just one strike price above. The call that you are purchasing will cost a premium for the option that you will pay for. That call that you are selling that is one strike price above will offset the total cost of the initial call that your purchase.
There idea is that we are using these strategies in up trending stocks that we see have strong fundamentals. The objective is to have price close above the strike price of the option that you sold. In the event that doesn’t go as planned the alternative would be to allow the option value to rise above your break even price to secure profits. This can happen if the stock pushes up to new highs or just continues on its progressive up trend.
DELTA AIR LINES INC (DAL)
Delta Air Lines has maintained legacy carrier status for as long as I can remember. In relation to other airlines in the industry Delta has maintained positive return on assets and shown to be extremely versatile in their ability to adapt and adjust services and equipment to best fit the needs of their customers.
Although over all sales have slowed down a bit over the last 5 years we are seeing some rise in Airfares to help offset that balance. With Airfares rising this can signal to the revenue per seat being increased.
Fundamentally Delta is continuing to advance their fleet and has had success in their latest venture with starting GOL airlines in South America. To read how GOL is performing read When Will the 737-MAX be Ready for Take-Off.
Disclaimer: This is not meant to be a trade recommendation or suggestion but just a current day example as to how one would set up this trade.
Let’s set up a quick example of a Debit Spread on Delta (DAL).
Price is in a nice strong uptrend for the year. We see how price has tested on this trend line 4 times and is showing a strong rally after this last touch. If you notice price moves up in waves as it tests between price levels on its path to new highs. Based on how the current trend is we can look for price to continue on its trend up.
To set up a Bullish Debit Spread on Delta we first go into our Options chain on our Online Broker and identify the next strike price above what the current stock price is at. We want to make sure we allow enough time for the stock to move in the desired direction so we are going to pick the options that expire the next month out.
The next strike price up is currently $60. So we are going to buy the $60 Call with the October 18th 2019 expiration date. This option is currently trading a $1.75 a contract. We are then going to sell the option for the next higher strike price with for this stock is the $62.5 strike. This option is currently selling for $0.73 a contract.
Since we are buying the $60 strike price call for $1.73 a contract and then selling the $62.5 strike price call for $0.76 the total cost of the spread will be $0.97 per share. Each options contract is connected to 100 shares of stocks.
The price to be able to purchase 1 order of this spread total cost can be seen below. We see the total cost of $105.95 for the order which includes the $8.45 that TD Ameritrade is charging for their commissions.
This window below that can be accessed when playing the order on your online broker is going to give us to final details as to the details of our order. We can see the total cost of the spread above and what kind of order is being place. This is a Market Order meaning we want to enter the trade at the current market price of the options.
Near the bottom we can see the Risk Profile of this trade. Our initial investment is the most that we can loose if this trade goes against the direction we anticipated. The curved line shows the value of our Option in correlation to the price of the underlying stock.
We see how when price moves up passed $62.5 we are in full profits on the spread which would result in $152 profits earned on a $97.5 investment.
This trade has the potential of earning 156% returns if it goes in the direction we desired. For this to occur the stock only needs to move up about 1.5%. The maximum potential risk for this trade is the $97 that was initially invested. The only way for you to be entirely out of your initial investment in full is if price drops down below $50 a share and stays there at the time of expiration on the option.
Some brokers have the ability of providing a percentage of probability for the trade. Here we can see there is only a 37% probability of the trade climbing above to $70. The percentage of change various based on the stock and how fast price moves for that stock. We can use these scales to help us determine the risk that is associated when entering these trades.
Once we feel confident in our trade set-up we can then proceed to submit the trade and allow for time to work in our favor as we allow the stock price to move accordingly.
Keep in mind that this style of trading is not intended for the investor that is not present in the market. The potential risk of you loosing your entire investment as we have seen is very possible. This style of Debit Spread is ideal of generating additional income on stocks on a weekly and monthly time frame.
Buying calls and puts have great risk and rewards to their nature. Learning new strategies to help mitigate risk and lock in profits is key in developing your skills as an options trader.
Understand that investors must learn to actively manage not just their accounts but also their time. Taking the time to learn certain skills and strategies that can prevent future losses will not just save you money but also time from having to learn it from your own mistakes.
Debit Spreads allow you to be able to capitalize on the movement of a stock while reducing your initial investment required and clearly defining a profit goal and risk. We took a look at a theoretical example of Bullish Debit Spread on Delta Airlines (DAL) for October as we see price pushing up towards new highs.
Keep in mind with this style of spread the goal is to have the price of the stock push above your short call strike price. In the event price does not push up that strong then close the spread with a profit above breakeven price and secure your profits.
Come back next week as we review our trade on Delta (DAL) to see how the stock played out. Today is the last day of the trading week and after a strong bullish week many investors are sitting at the edge of their seats to see what’s in store for today. Happy Trading everyone!
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