Vertical Spread

In the Selling Option post, I mentioned Selling Option strategy has limited reward (the premium we received) with unlimited risk.

There is a way to address this unlimited risk by buying another Option with the same expiration and have the same underlying asset.  That is a Vertical Spread.

A Vertical Spread is the simultaneous purchase and sale of options of the same class (calls or puts) and expiration, but with different strike prices.

By selling a Put at a higher price and buying another Put at lower price, it is called Bull Put Spread or Credit Put Spread.  It is called Bull Put Spread strategy because it is a Bullish strategy.  It is called Credit Put Spread because you will receive a positive cash flow or credit by executing this strategy.

Let's use a Example to compare and contrast Naked Put strategy with Bull Put Spread strategy.

ASML has been in a bullish uptrend throughout 2013.  The recent weakness has sent the price retrace to price support at 92.30.  Our Stop Loss is the last swing low support at 87.00

Selling Naked Put
There is no Strike Price at 87.00.  There two nearest are 85.00 and 87.50.  I therefore chose 87.50 Strike price with December Expiration : ASML Dec20'13 87.5 PUT.




I queue for mid point 1.63 (Bid is 1.55; Ask is 1.70).  Didn't get it after 1 hour.  Decided to just buy from Bid (ya, it dropped from 1.55 to 1.50).  So, I received $150 (before commission) in premium.

With the margin of $1,384, the ROM (Return on Margin) is 150/1384 = 10.83% for 63 days.

Maximum loss is unlimited or price drop to 0, ie 87.50 * 1 * 100 - 150 = $8,600.


Vertical Spread : Bull Put Spread / Credit Put Spread

Components : Sell ASML Dec20'13 87.5 PUT
                      Buy ASML Dec20'13 85 PUT

As the premium for the spread is very low, just $24 for 1 contract at mid point $0.48.  I have to increase to 5 contracts to have a comparable size with the Naked Put position.


Same as Nake Put trade, I queued at mid point $0.48 for 1 hour without filled.  Decided to just take bid price 0.35.  Therefore, premium collected is $175 (before commission).

Margin, however, is only $1,250 lower than Naked Put 1 contract margin.  ROM is 175/1250 = 14%.

Maximum loss = (87.5 - 85) *5 * 100 - 175 = 1,075. (difference between strikes minus credit)



Summary:
Vertical Spread address the unlimited risk we have when selling Naked Put.  In addition, it requires less margin and provide a better return on margin.

Weekly Review

Trade 1 : Buying Put Option - KO NOV2013 40 Put and KO DEC2013 40 Put

For the past week, KO moving sideway around the 39.00.  Instead of closing all position, I close all the position for Nov contract, leaving Dec contract to monitor.

Unrealized P&L ($):
As at 04-Oct : 355 (Nov: 240; Dec: 115)
As at 11-Oct : 157 (Nov: 134; Dec: 64)
As at 18-Oct : -100 (Nov: -70; Dec: -30)
As at 25-Oct : -56 (Dec: -56)

Realized P&L ($):
KO 16NOV13 40.0 Put : $236.46 - $343.13 = $-106.67

Weekly Review

Trade 1 : Buying Put Option - KO NOV2013 40 Put and KO DEC2013 40 Put


The retracement for KO was strong.  It touch the second down trend line, approaching the first resistance line at 39. 

The unrealized profit I had 2 weeks ago has become unrealized loss.  

Unrealized P&L ($):
As at 04-Oct : 355 (Nov: 240; Dec: 115)
As at 11-Oct : 157 (Nov: 134; Dec: 64)
As at 18-Oct : -100 (Nov: -70; Dec: -30)

Do I continue to hold, hoping that it will resume the downtrend movements?  Or do I cut loss now?  I will wait for the next 1-2 candles to make the decision.  If it raise and hold above the second down trend line and 39, I will close all position and cut loss.

Trade 2 : Selling Put Option - F Oct19'13 15 Put

F went up with the general market when debt ceiling lifted, government shutdown ended.  The contract expire worthless.  I got to keep the full premium of $292.29 (as stated in this post) without paying another commission to close the position.

Weekly Review

I have been exploring some other strategies.  However, I didn't reach anything conclusive to share yet.  I hope I will be able to share it this coming week.

For now, I will just do a weekly review of the trades taken.

Trade 1 : Buying Put Option - KO NOV2013 40 Put and KO DEC2013 40 Put

KO stopped the downward movement and started to retrace.  Although I believe that it is still downtrend, I need to be aware that I am the Buyer of the option.  Time is against me.  For the November option, I only have 1 month left.  Time value decreases much faster towards expiration.  I will need to take profit as soon as price resume the downwards movement.

For this small retracement, my Unrealized P&L $157.

Trade 2 : Selling Put Option - F Oct19'13 15 Put

F stayed quite flat for last week. The contract will expire on 19-Oct, which is just 1 more week.  I am aware that the debt ceiling deadline is 17-Oct.  These few days will be quite volatile.  However, I believe that it will stay above Strike Price 15.00.  So, I am going to hold till expiration.

Unrealized P&L as follow:

Weekly Review

I am going to show a few trades I took when I just started Options Trading.  They are all done in demo account.

Trade 1 : Buying Put Option - KO Dec20'13 40 Put

This trade was discussed in Buying Put Option post.  I ended up buying 2 November contracts and 1 December contract on 24-Sep as follow:

The current Unrealized Profit is as follow:


This is how the KO Chart looks like as at 4-Oct close.  KO has traded downwards as what I discussed.  While it still has some room towards the next resistance, the Pin Bar formed is getting me worried.  If the next day bar is bullish, I will exit 50% or totally for November contract.  Will keep the December contract as I still think KO still has some room to go down further.

Trade 2 : Selling Put Option - F Oct19'13 15 Put

This trade was discussed in Selling Options.

Since the contract will expire on 19-Oct, which is just 2 more weeks, I am going to let it expire instead of taking profit of $267 out of $300.  Looking at the chart, unless something drastic happens, price should stay above Strike Price 15.00.