Rationale for Options
1. Trade in Index like SPX
- quick and easy
- no earnings / dividends concern
- no big jumps due to random news
- cash base, no stock to exercise
- heavily traded
2. Need to be a Seller, not Buyer
Buyer gain when stock UP = 1/3
Seller gain when stock NEUTRAL, DOWN = 2/3
Options
Expiration - Work against Buyer, For Seller
Strike - Buyer need overcome, Easy to Avoid
Premium - Buyer Pay, Seller Receive
3. Expiration Selection
- Put time on our side
- Sell from 45 days-21days or closer to expire
4. Choose Low Probability Strike
- Narrow Strike Selection
- Avoid strikes, look for strikes far away
5. Have a built-in Protection Plan.
Avoid naked option
Bull Put Credit Spread - when we are bullish
- Sell Put
- Buy Put at lower price to protect stock dropping
Bear Call Credit Spread - when we are bearish
- Sell Call
- Buy Call at higher price
6. Don't be Greedy
Terminology
Let's explain this firstly by the title "Writing Bull Put Spread"
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
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
2. Take profit at 50%
3. More importantly, if bullish, look for options that have LESS than 40% of getting hit. Usually this is called ITM(%) (in-the-money).Since we are sellers (writers) of the option, we hope that the option will NOT be in-the-money other the buyer will strike. So the 40% example means its is less likely for the strike to happen.
ITM is NOT the same as DELTA, but there are very, very little difference between them. So if some brokers or trading platforms do not have ITM but have DELTA, then DELTA can be used.
Choose both Put(215) and Put(210) together, ie
- same Expiry
- same no of units
- ITM of Put210 is half (50%) of Put(215)
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
The Bear Credit Spread is
- 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.
- 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.
-------------------------------------------------------
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.
Ref: VV SOTW - 23 Oct 2020 - 'Risk vs Reward - Options Trading Guide'
Resources
A few resources are listed here for your convenience. We do not have any opinions on any of these particular resources.
Lars Tyge Nielsen - Understanding N(d1) and N(d2): Risk-Adjusted Probabilities in the Black-Scholes Model
Notes
Why ? Stocks go up, down sideways. Seller has two ways to win, buyers have one 2 way to win.
1. Sell 21-45 days options
2. Sell at far away strike prices
3. In bull case, sell put at 1.65 for 2.45, and buy put at 1.6 for 1.15. ner credit is 1.3
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