A lot of friends approached me and asked what is the best options strategy to deploy if he/she intend to start trading options with USD5k-10k capital? My answer is trading credit spread (bull spread or bear spread or combination of both). Trading credit spread is entirely different from few strategies that I shared in my earlier post. There is no concept of cost reduction and there is also no intention to buy the stock upon options maturity. Hence, I would categorize this strategy as a slightly aggressive strategy.
There are two types of credit spread, Bull Put Credit Spread and Bear Call Credit Spread.
Let’s decompose and explain Bull Put credit spread using Lifestyle Options Trader’s method.
Bull Put Credit Spread (BPCS)
1. Bull -> Bullish Outlook
2. Put -> Put Options
3. Credit -> Receive premium
4. Spread -> Consist of 1 Long and 1 Short position
What does this mean if we were to deploy this strategy? It means we expect the stock price to go up or flat. We construct this strategy using two Put Options, one long (buy to open) position and one short (sell to open) position and we will receive premium.
Let’s see the example below:-
This is Apple stock and it is trading at $113.18 (See 1). As we expect the stock price to go up or flat, we can construct BPCS using two Put Options. In this example, we select 110 strike and 105 strike.
1. We will buy to open 105 strike at $3 (mid of $2.96~$3.05) and;
2. We will sell to open 110 strike at $4.65 (mid of $$4.60~$4.79) (See 2).
3. We need to open this two position together
We will receive a premium of $1.65 ($4.65 – $3) from this spread trade. The strike wide is $5 (110 strike – 105 strike).
With this strategy, as long as the Apple stock does not drop below $110, we will take $1.65 as our profit ($165 profit for every options spread we put up) upon options maturity. As the stock is currently traded at $113.18, there is $3.18 ‘buffer/cushion’ before we take action to repair. If we do nothing and the stock price drops to $100, the maximum lose incurred would be $3.35 ($5 strike wide – $1.65 premium receive). The maximum lose would still be $3.35 if the stock price drops all the way to $0.
There are several repair strategies if the stock price goes against us. I will slowly reveal it in the future post. 🙂