Option Spreads

Many people have asked me how do I trade credit spreads? Well here is the ebook to show you how to trade credit spreads. It is the basic method I use to trade-

Do you want to learn an option strategy that helps you sleep better at night?
How about a 5 to 15% profit with an 80% probability of success on each trade?

To learn more go to —> Conservative Options right now!

This was such a great explanation of selling calls against stock I just had to post it for you here. It comes from a fellow forum poster Prohobo owner of Market Preview

Selling calls against stock come with many names:

“Covered Calls” (calls are sold against the stock and therefore “covered” by the stock purchase)

“Buy Writes” (Sometimes used as on bothsides of the trade - either buying the stock and writing the option OR buying the option and writing the stock. I have heard brokers for decades use this interchangeably (rightly or wrongly) synomous with Covered Calls.

“Over Write” or “Call Writing” (Usually the stock is already owned and the calls are sold against an existing stock position).

At the end of the day - it doesn’t mater WHAT you call it. All you are doing is selling calls against a long stock position.

The trick is not only picking stock direction, but picking the right strike to sell and for the best premo.

There are several ways to aproach it, but no correct way.

Some traders look for what is known as STATIC RETURN. This is simply the PREMIUM over parity (extrinsic value) (AKA: Juice, Time Value, Premium, etc.). Simply EVERYTHING over intrinsic value. This value is then divided by the stock price to get static return. If the stock were NOT to move the return value would be X% vs. the underlying price.

Example:

Stock XYZ is trading $101.00

The 100 level call is trading $9.00

The EXTRINSIC VALUE of the 100 call is $8. Since they are 1 dollar in-the-money (ITM).

If you bought the stock at 101 and sold the call at 9.
If the stock closed at 101 on expiration (unchanged from today). The static return would be 8% (8/101). If this was done for on an option that expires in 60 days (2 months). Your annualized model would be 48% annualized static return on the strategy. (8 * 6).

This doesn’t mean that you will get 48% return, the model is just measuring static return.

Another way to look at it is that if the stock move up ANY AMOUNT your return is capped at 8% for that time perioud.

Additionally you have a 8% downside buffer to break even.

A easy way to look at it - selling the 100 level call for 9 is like pre-selling the stock at 109, after you just bought it for 101. A $8 profit - if the stock closes at 101 or higher.

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Some traders look for short term forecasts as to stock direction. Let’s say your expectation was for the stock to move up to 110 in 2 months, which call would be best to sell based on your expectation.

95 Call for $12
100 Call for $9
105 Call for $7
110 Call for $5

The answer is simple: The 95 call is like selling stock at $107, the 100 call is like selling stock at 109, the 105 call is like selling stock at $112, the 110 call is like selling stock at $115.

However - lets look at the premium levels.

The 95 call only has $6 of premium (12-(101-95) or static return of 6% with NO upside potential. Max return of 6%

The 100 call only has $8 of premium (9-(101-100) or static return of 8% with NO upside potential. Max return of 8%

The 105 call is ALL premium $7 since it is out-of-the-money OTM a static return of 7%, but an upside delta return of an additional $4 (105-101). Net max return of $11 or 11%.

The 110 call is ALL premium $5 since it is OTM a static return of 5%, but has an upside delta return of an additional $9 (110-101). Net max return of $14 or 14%.

As you can see the 105 and 110 call have less premium than the ATM (at-the-money) 100 call ($8 of juice). However, since they are OTM they have the added benefit of not off-setting HARD DELTAS for several points - giving you a bigger return if you are RIGHT about direction.

The 100 call is the safe bet - it gives you the biggest downside buffer and highest static return. If you want the added horse power of HARD DELTAS then the 105 or 110 call is the choice.

As you can see it all depends what your expectations and perpensity for risk is.

Remember - if your calls are getting called away - your are MAKING money. It is a GOOD THING. Only fools who have covered-calls on do NOT want to be called. They haven’t figured out the math yet. Believe me - I have heard even a couple of retail NOB brokers say - you don’t want to be called away on covered calls you are just giving away upside. Then I remember why they are a broker and not a trader. (Other than tax purposes - you really do want to get called away - the earlier the better).

TradeKing, the options broker, has just announced that one of my favorite options mentors, Dan Sheridan, is joining their All Stars Blog. Heres an excerpt from the press release -

BOCA RATON, Fla., July 7, 2008 – Online discount broker TradeKing (www.tradeking.com) today announced the latest additions to its All-Star roster of trading professionals providing commentary on individual investors’ online trading as part of the TradeKing Community.  Beginning immediately, options trading luminaries Jonathan (“Doc”) Maher, Ph.D., and Dan Sheridan will join Larry McMillan and TradeKing’s own Brian Overby and Nicole Wachs, expanding the lineup of options pros offering “All-Star Commentary” on individual investors’ online trading.  Commentary by these professionals help TradeKing Community members expand their knowledge of options trading and learn from one another’s trades in real-time with tips and insights from the financial world’s thought leaders.

Here’s the rest of the Press Release from the Miami Herald - TradeKing(TM) Announces New ‘All-Star’ Lineup; Welcomes Heavy-Hitting Investment Professionals to its Award-Winning Online Community

This is an exciting addition and worth a look see at TradeKing and its commitment to providing appropriate options knowledge for their customers.

You may be wondering why all the hype recently from the Dow Jones Industrial Average’s (DJIA) drop yesterday, why it was such BIG news? Well it is from breaking one final major support, the 52 Week Low.

THE final support of any stock or index is the 52 week low, the majority of the time a rebound will be set off when the price reaches this level; however in some cases as what happened yesterday with Oil reaching over $140 an all time high and all the economic woes being thrown about and inflation being up, the support could not hold. So yesterday was big news as the DJIA took the plunge and closed below the 52 week Low and today it is still making new lows at the time of this writing it is another 60 points down.

For us that trade the SPX we still have not broken the 52 week low however if the Dow continues its decline which I assume it will especially after testing the previous support and falling back quickly, it will soon be breaking its 52 week low which is at 1256. With the market the way it is and a soft resistance at 1300 we could start looking for Bear Calls just above the 1300 point, just remember that this is a soft resistance and can be broken easily on a turn around.