Hey everybody! Man,
it’s been a long week. Like most folks I have a day job. Blogging and trading options is just
something I do on the side for fun and profit.
I’m blessed to have been employed with the same company for sixteen
years and hopefully I’ll be able to retire one day with a boat load of cash
generated from years of compounded earnings from options trading. With that in mind let’s get back to it!
So far we’ve talked about what options are, the different
types of options (calls and puts), and how to read an options chart. Let me say this before we continue. There are thousands of books and websites you
can check out that will expose you to more information about options than you
can possibly imagine. It’s quite
overwhelming! But I’m of the belief that you really don’t need to know it all
to get started and be successful.
One of my duties at my day job is being a regional defensive
tactics instructor. With the experience
I’ve gained I could teach you all types of exotic take downs, pressure points,
and submission holds but when it’s all said and done if you, as they say, “Hit
them back first!” you have a great chance of winning most physical
confrontations. I approach options
trading with the same attitude. I may
not win every fight (or trade) but I will knock my share of bad guys out! Now don’t get me wrong, I encourage you to
read and learn as much as you can about option trading but my plan is to get
you up and running as quickly as possible.
In this post I want to talk about the type of option trade I
use exclusively. The strategy has
several different names but I just call it a basic “spread”. Specifically, it’s called a “bear call spread”. More about the bear call thing later. Let’s break it down!
A spread is created when a trader “sells” an option at a
strike price (aka short strike) that’s a good distance away from the current
price of a stock. Then at the same time you
“buy” an option at a strike price (aka long strike) that’s even further away
from the stocks current price. The goal
of entering this type of spread is to choose a short strike that the stock
price will never touch. So let’s say stock ABC’s current market price is
$60. To create a spread we could sell an
option at the $70 strike and simultaneously buy an option at the $75 strike. When we sell the $70 strike let’s say we get
paid 1.00 ($100), but the cost to buy the $75 strike is 0.60 ($60). For every spread contract we obtain, your
broker would deposit $40 into your account
($100-$60). As long as ABC’s
stock price doesn’t touch or go past $70 we win and get to keep all our
income. In this example the total amount
of risk would be $500. The easiest way
to calculate your risk is take the distance between the two strike prices (5 in
our example) and multiply it by 100.
Most traders normally use either five or ten point spreads. The reason why we buy the long strike is
because it limits the amount of loss we would incur if the worse case scenario
happens. In our case the worst case
scenario (max loss) would be when stock ABC touches or goes higher than $75
(long strike).
Well, that’s the strategy!
It’s nothing fancy but it works.
The key to making consistent monthly income with spreads is to have a firm
set of rules to follow. The rules determine which spreads to enter into and what to
do in the rare occasion things go south.
Next time we’ll start talking about some of the rules of the game. See you guys next week!
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