Will it go up, sideways or down? This is the question for traders that ranks right up there with is there life after death. You may have the faith but you’re never really sure. And so it goes every trading day. Some days are high probability days and others-many others- are iffy. Wisdom might say to stay out of the markets on anything but high probability days. But high probability days may only happen on relatively few trading days. But there are ways to play the game and limit loses while being exposed to moderate probability. That’s what makes trading stock options so potent; more opportunities to trade and at reduced pre-determined risk.
Take today’s markets. Highly volatile you might say. But stock option traders like volatility. Recently, the VIX has shown some increased optimism as it has moved lower. Don’t ask why. There are many reasons depending on your point of view and apparently by the actions of the VIX, there are more traders and investors starting to think positively; that maybe they think that the credit problems have reached bottom and the Fed’s actions may have put on the panic brakes just in time. So, with this recent change of collective heart, what stock option strategy might a trader use? Here’s one.
It’s called a Bull Put Credit Spread. The Bull means that you are leaning more to the belief that the underlying stock has a higher probability of going up rather than down. Or that it might not move at all. But you are leaning to the up scenario.
The Put means that you are going to sell a Put contract (or many) believing that there is less a probability of the stock going down than up. In which case, the Put will expire out-of-the-money and you keep the premium from writing the Put.
The Credit means that you will-after all is said and done-have a credit in your trading account because you will receive more money than you will have to put out for the spread portion of the strategy; thus, a net credit.
The Spread refers to your insurance. You see, what happens if the market laughs at your meager strategy and decides to go against your belief that the market will go up and it takes an abrupt down turn. In that case, the option you wrote might be assigned and you will be exposed to the situation of going into the market to buy stock at a loss from the strike price you wrote the option for. To protect against that possibility, you buy an out-of-the-money put that will make money if the price plunges below the strike price. This will limit your loss to the price of the written Put plus the credit and less the purchased Put.
I know, it can be a bit confusing that’s why options require serious study but the main idea behind the Bull Put Credit Spread is that the trader on the other side believes that there is a chance that the underlying stock will go down but you believe-by way of your analysis of the underlying stock and the sentiment demonstrated by the latest VIX that the stock has a better chance of going up and the trader on the other side will lose the premium they paid you for writing (selling) the put.
To find out more about online training courses for stock options, I recommend you take a look at www.optionsuniversity.com