Vertical Spreads


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	------------------------------------------------------- Vertical Spreads ------------------------------------------------------- A vertical spread is a directional price movement play. A price spread can be placed on a stock you expect to move up in price or you expect to move down in price, which fits well with the range bound strategy used at whentobuy.com. There are two types of vertical spreads. First, a credit spread allows you take in cash at the trade. Second, a debit spread allows you to buy options that take money from your account as a debit, then you sell the options to realize the profits earned. Generally, the credit spread has much less speculative than debit spreads. As a member you will have access to a spreadsheet we have created to assist you keep track of each of your spreads and monitor the progress on a daily basis. Credit Vertical Spread For small investment portfolios credit spreads are a great play to build cash value. Combinations of calls or puts creates either bull or bear plays. Credit spreads can be created using a combination of Puts or Calls. Buying a call is comparable to buying a stock or a long position while selling a Put Option is comparable to Selling Short a stock. Bull Put Credit Vertical Spread This Bullish play involves taking cash into your brokerage account in the form of a net credit. A combination of Selling a Put in the money and Buying a Put one strike price below the Sold Put in the same expiration month. As the stock price rises from the current price to a price between the break even and net credit earns a profit. When the price drops while holding the stock you use a Stop Loss transaction to limit your loss. An option spread offers a unique advantage, should the stock price drop you can Buy the Sold Put to close half of the spread. You then have unlimited profit from the Bought Put. Stock portfolio management software does not have reporting capabilities that are conducive to spreads. The spreadsheet below will assist you record the spread transaction and manage its performance on a daily basis. Debit Vertical Spread The Debit Vertical Spread is a directional investment play that provides leverage over a limited range of stock prices. The Debit Vertical Spread can be set up for a Bull or a Bear play, which we present separately. As in all investment plays you must know the cost of the trade, the breakeven, the expected time in the trade and the potential profit. As a regular part of the weekly research whentobuy.com computes all of this information for you. Remember, the reason for the Debit Vertical Spread is to control more shares of the underlying stock at a lower cost. Additionally, constructing this option play is to invest in stocks that are displaying a historical cycle of moving from low to high prices over a short period of time, usually 10 to 60 days. Bull Debit Vertical Spread Combining the buying of a lower strike price call contract with the selling of a higher strike price call contract in the same month creates a spread between the two strike prices. Options are time dependant, so you need sufficient amount of time in order for the stock prices to move through their cycles. Generally, options should be purchased with 120 days to the expiration date and should be closed out before the last thirty days. Since the value of the option trade decays over time the last thirty days the options lose the greatest portion of their value. If you believe the option combination needs more time simply close the current option trade and open a new Vertical Debit Spread with a new expiration date. The risk profile for a Debit Vertical Spread can be seen below: The maximum amount at risk with a vertical spread is the cost of the spread or the net debit. The maximum loss occurs if on the expiration day the current price of the stock falls below the lower strike price, in the above example the current strike price must fall below $17.50. Keep in mind we still use a Stop Loss order to prevent a complete loss in the trade and we never hold the stock in the last thirty days. The total premium would only be lost only if we did not use a Stop Loss and let the option expire as you watched the prices drop! Like all good things there is a trade off! Here the cost of the spread is much less than the cost of buying the shares of stock. This means the maximum profit is capped at the higher strike price of $22.50. Below an actual example of a Bull Debit Vertical Spread created for Cardinal Health, Inc. on June 10, 2002. Purchasing 10 contracts would be comparable to buying 1,000 shares of stock. The stock purchase would have cost $65,100 while a comparable 10-contract purchase cost only $2,250. Notice a 3% Stop Loss on the price of the stock at $65.10 would be $63.15. Maintaining the Stop Loss of $63.15 translates to a 20% Stop Loss percentage on the option trade. If your brokerage firm allows a Stop Loss transaction on option spreads based upon the underlying stock price this option should be used. Whentobuy.com and this newsletter are provided for educational purposes only. No statement in the documents should be construed as a recommendation to buy or sell a security or to provide investment advice. It is possible at this or some subsequent time, the editors or staff of whentobuy.com may own, buy or sell securities discussed. All investors should consult a qualified professional before trading in any security. Before trading stocks or options you should understand the risks. In addition, anytime a stock or option is purchased or sold, transaction costs including brokerage fees are at risk. The information provided has been obtained from sources deemed reliable but is not guaranteed as to accuracy and completeness. Back \| Vertical Spreads \| Speculation Calls & Puts \| Price Straddle \| \| Bonus Research \| Weekly Option Plays \| Research Performance \| My Options Playbook \| \| Weekly Research \| My Playbook \| \| Order Now \| Return Home \| Home Business \| Digital Economy \| Sign In \| Disclaimer \| Training Center \| FAQ \| What's New \| Contact Us \|