Bear call spread
Got a little more time now for this.
If you really think a stock is going down you could just write a naked call. Not a good idea cause if the stock kites, instead of going down like you thought, you are left holding the bag with a potential unlimited risk. Most brokers will not allow a naked call for this reason.
But if you sell the call and then buy a call at a higher strike you have limited your potential downside to the amount of the spread minus what you made putting the spread in place.
The big thing to remember is that this spread, bear call spread, is only to be used if you or conditions are really bearish for the stock.
Same thing for the bull put spread. The word bull/bear in the name of the spread is the whole key.
Example: Right now, just before earnings come out for IBM (should be next Monday or Tuesday I think), the stock is sitting at about $96.20 Do we believe the stock is going up or coming down on earnings?
If we think up (bull put spread), we could sell the APR90 put for $1.80 and buy the 85 for $1.05 and make a $0.75 profit in 5 days as long as the stock stays above 90. We take in the $0.75 today and the stock will have to drop $6.20 before we even care. At $89.25 we start losing money but the most we can lose is $4.25 even if the stock goes to $50.
So the real deal here is that (1) the stock can go up – we make money, (2) the stock stays the same – we make money, (3) the stock goes down less than $6.20 (stays at $90 or above)– we make money or (4) the stock really goes down – we lose is $4.25. If it works, that’s $0.75 made on a risk of $4.25, 15.7%. Not too bad for 5 days!
OTOH
If we think down (bear call spread), we could sell the APR100 call for $2.25 and buy the 105 for $1.05 and make a $1.20 profit in 5 days as long as the stock stays below 100. We take in the $1.20 today and the stock will have to go up $3.80 before we even care. At $101.20 we start losing money but the most we can lose is $3.80 even if the stock goes to $150.
So the real deal here is that (1) the stock can go down – we make money, (2) the stock stays the same – we make money, (3) the stock goes up less than $3.80 (stays at $100 or less) – we make money or (4) the stock really goes up – all we lose is $3.80. If it works, that’s $1.20 made on a risk of $3.80, 31.5%. Really, not too bad for 5 days!
I suggest you check the markets Monday and PAPER TRADE this play and others that you can find that look hopeful.
PAPER TRADE – don’t do this with real money till you’ve done it many times and understand the mechanics of the trades.
I think this is a pretty good explanation but you need to read it three or four times and do your own math so you really get it.
All you're really doing here is selling a naked put because you think the stock is going up or selling a naked call cause you think the stock is going down but buying insurance just in case you're wrong.
If you're going to do spreads I think you should always do them this way, bull put/bear call, so you get paid to put the spread in place. You limit your potential over a naked position but you cap your possible loss. With the time and money at risk this example, do you care if your 5 day gain is limited to 15 or 30%. I sure don't.
HJ |
