Options Trading: Spreads
Spreading is a strategy that involves buying a call option and selling another call option with a different strike price for the same month. You can do the same with put options as well. There a different variations in spread trading and you can use it well in bullish, neutral or bearish markets. Purchase and sale of the options involved in the spread are executed simultaneously. Buying the option is a long position, selling the option is a short position.
For example, consider an optionable stock, index or an ETF. For this example, consider S&P DEP RECEIPTS (AMEX:SPY). Looking at the historical prices, it has been trading below 124 for months and currently trading at around $119. Look at the option prices for the month of Nov-05. If you sell the Nov call with strike price of $124 at $0.50 and buy the Nov call with strike price of $127 at $0.15, you will receive a net credit of $35 per contract. As long as the SPY closes below $124 by Nov-05 option expiration date (Nov 18th, 2005) you will make the maximum profit. That is rate of return of more than 13%. This is an example of Bear Call Spread. Bear Call Spread strategy is used on stocks that are downtrending or going sideways.
Few other things to consider in this example are Break even point ($124.35) and closing out the spread if your bearish expectations go wrong.
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