The bear credit spread table highlights stocks that have options trading at uniquely high premiums. We attempt to take advantage of this by selling an out-of-the money call and buying the next higher strike price call as protection from a runaway. This is a bear credit spread. It is "bearish" because we want the stock to not go up (usually it can still go up another 10% and we are still ok). It is a "credit" because the option we sell brings in to our account more than what we spend for the next higher strike price call that we buy as protection. And, it is a "spread" because we are selling and buying options on the same stock.
For stocks trading under $25, we try to get a spread of 1/2 to 5/8. For stocks trading above $25 we try to get 1 1/4 to 1 1/2. Until the on-line brokers provide us an ability to enter spread orders on the internet, you may find at times that you have to leg into these positions. (Schwab now allows spreads as part of their online service.) Of course, a full service broker can enter these trades for you so that you don't have to worry about being left on one leg.
It is our hope that the stock will stay below the strike price and that both options will simply expire worthless. To protect ourselves in the event the stock runs up on us, as I mentioned above, we always buy the next higher strike price call option. Thus for stocks under $25, our exposure is $2.50 less the premium received from the option we sold times 100 times the number of contracts. What's that last sentence mean? It means for example that if we: 1) sell 16 contracts on stocks under $25 - and the spread is 5/8; OR 2) sell 8 contracts on stocks above $25 - and the spread is 1 1/4; then our total maximum gain in either trade is $1,000 (less commissions). It also means that our total maximum loss potential for either trade is $3,000. If the stock finishes expiration Friday between the two strike prices, then the loss will be less than the maximum. I have provided June, July and August tables with easy to read win/loss columns on the site for your review.
You are not cleared to do spreads? Not a problem. You can also consider simply buying puts on these same stocks. While there are many strategies to employ, I will mention a couple. You may buy a put that is deep in-the-money. For example, a stock was trading at $11. I bought the $15 strike price put for $4 1/4. This will provide near point for point movement with the stock. Another strategy is to buy at or out-of-the money put options. This will provide the possibility of higher percentage returns, however, the trade-off is that the stock must fall more in order to enjoy such returns. Whichever you decide, and obviously you can use either or both on any particular trade, your results may vary greatly from the spread trade. However, having said that, there is no way to pre-determine what trade is best, they are simply different strategies. Only time and 20/20 hindsight will reveal the trade that would post the best gain. But that is not a bad thing...rather that's fun and good...you have to be disciplined and flexible to be successful.
For instance, if you buy an out-of-the money put and the stock just sits there, then you will lose while the spread writer will win. On the other hand, if the stock drops 10 points the spread writer will "only" make his locked-in profit, however, the put buyer will "hit a home run". Obviously, many variables of the foregoing example can occur. The beauty of this table is that you know your maximum exposure on each trade upfront.
Remember, I am not a broker, analyst or otherwise licensed in the securities industry. I have created this web site as an information tool for you. Please don't take any of my posts as recommendations, rather, consider each post and evaluate it for its merits. I have provided research links to many quality sites to aid you in your research. Also, don't be scared to spend a little money on a licensed broker. The final count isn't how much you spend, but how much you make. I truly enjoy providing this service and I hope you enjoy receiving it.
Sincerely,
Eric J. Aafedt
CoveredCall.Com, FounderPlease use your BACK button to return to previous page.