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Saturday
Sep242011

SK Options Trading Explains Bearish Vertical Call Credit Spreads

A Vertical Call Credit Spread is a strategy put in place by buying a call at a strike price of, let's say $75 and then writing (selling) a call at $70 with the same expiration date as the purchased call. In this scenario the current price is $69, meaning both calls are out of the money, so what you achieve by placing these two trades is a net credit. Therefore you effectively receive your potential profit at the start of the trade because the price you bought the call was less than the premium you received from selling the call at a lower strike price. However keep in mind that since your broker will most likely mark the position to market constantly, you cannot spend the net credit received.

This strategy is used when you believe an underlying security will fall, remain neutral or rise slightly. If this is the case, then the calls will expire worthless since they will be out of the money. Therefore the spread between the two calls becomes zero. As time passes and the probability that the calls will be worthless increases, the spread will move towards zero. This works in your favour as you have sold the spread at a price greater than zero.

With the calls remaining out of the money and the spread narrowing to zero, your position will increase in value each day, holding all factors the same. The change in a position’s value with time is often referred to as "Theta". Therefore this trade carries positive Theta as the time premium on the calls decays and the spread between the two prices moves to zero. Taking advantage of this positive theta is only possible if both options are out of the money and remain out of the money until the options expire.

The potential profits in this trade are limited to the initial net credit, which is the difference between the premium received from selling the calls and the price paid to buy the calls. Although the potential profits are limited, the potential losses are also limited. The maximum loss is the difference between the two strike prices minus the initial net credit received, multiplied by the deliverable shares in each call, and then times the number of contracts involved in each leg of the spread.

This strategy is different from simply buying puts because it does not rely on large percentage moves in the underlying asset. It requires that you pick the correct direction and the future volatility of the underlying security. It also differs because selling a vertical call credit spread will produce positive Theta, whereas simply buying a put option will generate negative Theta.

Examples of SK OptionTrader using this options strategy include a trade we entered on the 4th of November 2010. These two trades were placed because SK OptionTrader saw further sovereign debt problems in the EU and a fully priced in quantitative easing program by the Federal Reserve. Therefore SK OptionTrader decided to place two Bearish Credit Spreads on the SPY and DIA, (the S&P 500 and Dow ETFs.)

The first trade involved Buying SPY Dec 18 2010 $130 Calls @ $0.31 and Selling SPY Dec 18 2010 $129 Calls @ $0.43, which resulted in a Net Credit of $0.12.

The second trade involved Buying DIA Dec 18 2010 $121 Calls @ $0.20 and Selling DIA Dec 18 2010 $120 Calls @ $0.31, which resulted in a Net Credit of $0.11. On the 18th of November, SK OptionTrader signalled a close on both spreads. This was because SK OptionTrader was able to bank the majority of the profits on the trades one month before expiration. This resulted in a 12% gain on the SPY trade and an 8% gain on the DIA trade in just 14 days!

Being able to use this and many other options strategies effectively increases ones versatility in the market. Also using these strategies allows traders to place trades that more accurately represent their market views, which when correct, can lead to much higher profits.

Currently the SK OptionTrader model portfolio is up 407.38%, which means a $10000 portfolio invested in accordance with SK OptionTrader signals would now be worth $50,738.14. On average a position gains 42.43% in 45.85 days, which provides an annualized return of 113.83%. So now is the perfect time to open a subscription with SK OptionTrader and begin increasing the profitability of your options trading portfolio.

For those subscribers who are too busy to trade their own accounts we are now able to offer Autotrading programs with our SK OptionTrader service. One can sign up for autotrading with Global AutoTrading or eOption.

 

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