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| In this article I'm going to talk about some of the basic concepts behind option spread trading. Each
strategy is accompanied by an example |
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| Bull Call Spread |
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| When an investor purchases a closer to the money strike price call and sells a further away from the money strike price call. The investor pays a debit and that is the investors risk. The risk is limited and the potential is
limited. (moderately bullish strategy) |
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| The Trade: |
| The investor purchases a July Soybean 550/call and sells a July Soybean 650/call for a debit of 10 cents or $500(every cent in the Soybeans is = $50). Total risk is the premium paid or $500. Total profit potential is 100 cents or $1.00 = $5000. Breakeven is at 560 on expiration date. |
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| Bear Put Spread |
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| When an investor purchases a closer to the money strike price put and sells a further away from the money strike price put. The investor pays a debit and that is the investors risk. The risk is limited and the potential is limited.
(moderately bullish strategy) |
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| The
Trade |
| The investor purchases a July Soybean 550/put and sells a July Soybean 450/put for a debit of 10 cents or $500. The total risk is the premium paid or $500. Total profit potential is $1.00 or $5000. Breakeven is at 540 on expiration date. |
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| Ratio Bull Call Spread |
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| When an investor purchases call options and finances those long call options by selling a call or calls with a lower strike price to help pay for the higher strike priced calls purchased. A ratio bull call spread could be put on in any ratio that the trader desires. Whatever the ratio the buyer is simply purchasing more calls than he sells. The risk on this trade is limited and the potential is
unlimited. (bullish strategy) |
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| The Trade: |
| The investor sells 1 July Soybean 550/call for a credit of $1000 and buys 2 July Soybean 600/calls for a total debit of $1000 = no cost. The risk is limited to 50 cents or $2500. This is the difference between 550 and 600. The potential is unlimited. Since the investor bought 2 calls and sold 1 call, the investor has unlimited potential on the 1 extra call purchased. Breakeven is at 550 or below and 650. Any price above 650 is your profit. Let's say July Soybeans are trading at 750 on expiration date. The investors profit is $5000.
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| Ratio Bear Put Spread |
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| When an investor purchases put options and finances those long put options by selling a put or puts with a closer strike price to help pay for the lower strike priced puts purchased. A ratio bear put spread could be put on in any ratio that the trader desires. Whatever the ratio the buyer is simply purchasing more puts than he sells. The risk on this trade is limited and the potential is
unlimited. (bearish strategy) |
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The Trade:
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The investor sells 1 July Soybean 550/put for a credit of $1000 and buys 2 July Soybean 500/puts for a total debit of $1000 = no cost. The risk is limited to 50 cents or $2500. This is the difference between 550 and 500. The potential is unlimited. Since the investor purchased 2 puts and sold 1 put, the investor has unlimited potential on the 1 extra put purchased. Breakeven is at 550 or above and at 450. Any price below 450 is your profit. Let's say July Soybeans are trading at 200 on expiration date. The investors profit would be $12500.
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I hope this introduction to option spreading has given you some idea of the
potential in these strategies. Please feel free to contact me with your questions.
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John Garrity |
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