With coronavirus cases, social unrest, and geopolitical tensions all on the rise, the market looks uncertain going into the latter half of the year. But as an options trader, you're always looking for opportunities, even in a time like this. The only difference is that your strategy might change.
Right now, you're fighting volatility, but don't let that get you down. Volatility is actually good for options trading, but it does also leave you open to more downside risk.
If you are new to options trading, we have a great strategy for you that will maximize your chance of success. It also could limit your risk at the same time.
This is called a credit spread, and it is fairly simple to use…
What Is an Option Spread?
In any trading strategy, a spread is the difference between two instruments or securities. You buy one and sell another, usually related item. It could be two food stocks, such as Coke and Pepsi. Or it could be sectors, such as Tech and Health Care. Typically, this removes the risk of the overall market while concentrating on the reactive performance of just the two stocks.
However, in options trading, it's just a little different. You still buy one option and sell another. But most of the time, they have the same underlying stock. The difference could be in their strike prices, their expiration dates, or both.
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Let's keep it really simple and talk about different strike prices. This is called a vertical spread because, on options quote boards, different strike prices are arranged in a vertical list.
Vertical spreads can be bullish or bearish, depending on how you arrange them. They can be credit spreads or debit spreads – again, depending on the structure.
You may have read articles here on Money Morning describing debit spreads. They are called this because there is a net cost, or debit, to your account when you set them up.
A bullish debit spread is also called a bullish or long call spread. It's were you buy a call option with a strike price just below the current price of the underlying stock. You then sell the option with the same underlying stock and expiration date, but with a higher strike price just above the current stock price. The money you bring in by selling the higher-strike option partially offsets the price you pay for the lower strike.
This lowers your risk because you put up less money. However, although your profit maxes out, even if the underlying stock keeps rallying, it's still a great way to trade.
A credit spread is basically the opposite. However, if you are bullish, rather than buying a call and selling a call, you buy and sell puts. In this case, you buy the put with the lower strike and sell the put with the higher strike. It also goes by the names of bullish put spread and short put spread.
The trade works in the same way as the bullish debit spread. Here, instead of paying money now in hopes of getting back more later, you get the money up front and hope the options expire worthless so won't have to pay anything back.
For example, let's say you are bullish on stock WXYZ, which is currently trading at $65 per share. You buy the WXYZ Sept. 18, 2020 $60 put and sell the WXYZ Sept. 18, 2020 $70 put. Because the higher-strike put costs more, the net result is a credit to your account when you set it up.
If the WXYZ rallies to $70 by Sept. 18, both puts become worthless, and you keep the entire credit. However, in exchange for lower risk, you give up any additional profits, should the stock rally above $70.
Therefore, credit spreads are great if you expect moderate price movement in the underlying stock and want to limit your risk.
Why Startups Can Have an Edge During a Recession
Uber, Airbnb, Slack, Pinterest, and Venmo have something big in common – something other than their big names.
These startups were founded during the last recession.
And now, some of the most iconic companies of our time could launch into Fortune 500s during days like today.