Rationale for Options
Terminology
Writing means we are going to 'sell' an option. Which also means we get the money upfront because we are selling something.
Bull means we feel bullish, ie we think the underlying stock will be going up in the future.
Put - There are Call or Put options. Put means the right to sell a stock. Since in this strategy we are 'writing put', we are the sellers of the 'right to sell'. When someone buys the Put option that we sell, they (not us) have the right to sell at the Strike price.
Spread - We will be Writing and Buying which means our main strategy is to Sell (Write), but we also limit our losses by 'Buying' the same-type, ie Buy Put option.
Here is an example:
Sell Put Strike 215.00, Price 8.60
Buy Put Strike 210.00, Price 6.80
Diff Strike 5.00, Max Profit 1.80 (8.60-6.80)
Max Loss 3.20 (5.00-1.80)
A few more helpful items:
1. Option that has 45days left
Choose both Put(215) and Put(210) together, ie
- same Expiry
- same no of units
- ITM of Put210 is half (50%) of Put(215)
Bear Call Credit Spread vs Bull Put Credit Spread
- when your view is neutral or bearish
- you want to be protected from infinite losses
- you don't have an underlying asset
- Sell a Call option to get profit
- Buy a Call option in case the stock goes very high
Example:
AAA @ 20.94 on 1 Jan
Sell 1Feb $21.10 Call @ 0.20
Buy 1Feb $21.40 Call @ 0.08
The calculations are:
Max Profit = Sold - Bought = 0.20 - 0.08 = 0.12
Max Loss = gap in Strike price - Max Profit = (21.40-21.10) - 0.12 = 0.18
Breakeven = Low Strike Price + Max Profit = 21.10 + 0.12 = 21.22
This means from the day of action, when price is 20.94, if the trade goes against you, it need to go to 21.22 to breakeven, and go higher than 21.22 before you incur a loss.
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The Bull Put Credit Spread is
- when your view is neutral or bullish
- you want to be protected from infinite losses
- you don't have an underlying asset
- Sell a Put option to get profit
- Buy a Put option in case the stock goes very low
Example:
AAA @ 12.73 on 1 Jan
Sell 1Feb $12.30 Put @ 0.34
Buy 1Feb $11.80 Put @ 0.19
The calculations are:
Max Profit = Sold - Bought = 0.34 - 0.19 = 0.15
Max Loss = gap in Strike price - Max Profit = (12.30-11.80) - 0.15 = 0.35
Breakeven = High Strike Price - Max Profit = 12.30 - 0.15 = 12.15
This means from the day of action, when price is 12.73, if the trade goes against you, it need to go to 12.15 to breakeven, and go lower than 12.15 before you incur a loss.