Option debit spreads can be a very useful and in some cases, lifesaving tool when trading. The following example shows how that, even when the price of the underlying financial instrument goes against you, you can still make a nice profit on your investment. It just takes a bit longer, but it illustrates the superiority of this strategy over only ‘going long’ on call or put options.
The following example was traded on the Australian market, but the principles can apply to any market in the world.
In late August, I entered an option trade on ANZ bank. It was a debit spread, in this case, a ‘bull call spread’ which is where you BUY a call option (in this case) at a ’strike price’ just above the current market price, but also SELL another call option at a ’strike price’ higher up. In this case, it was an $18.50 / $19.00 spread. On reflection, it was a bad time to buy, but I had it pre-set in my broker account to automatically enter at a certain price and it did so. I was away at the time and not monitoring the market and had forgotten about this. The next day, ANZ came out with some bad news and the share price dropped about $2 (see chart again).
Now, if I had only entered the ‘buy’ side of the contract, this would’ve been very bad news. However, with a “spread” you can do interesting things…. I thought to myself, “if the share price has dropped, that means my ‘way-out-of-the-money’ $19 “sold” call option is now going to be very cheap” – cheaper in fact, than my bought position. (the share price was now about $16). Remember, this was a SOLD position, so why not buy it back when it’s practically worthless. Well, I had to wait a few weeks for it to get to the price I was prepared to pay, but last week the US stock market took a big dive and so the Aussie market followed the next day, particularly the banks.
The whole position (spread) had originally cost me 24.5 cents. This comprised the BOUGHT option at a cost of $1.48 less the SOLD option for $1.235 = 24.5 cents. Anyway, when the ‘big dive’ took place last week, I was able to “buy-to-close” the original SOLD position for only 12cents.
I thought to myself … “my total cost is now 24.5 + 12 cents = 36.5 cents. All I need now, is for the share price to rise a little, so that the original BOUGHT option comes up to about 38cents and I can get out and break even.
I was prepared to wait a few weeks for this to happen, because I had noticed that ANZ was in a sideways channel. Well, to cut a long story short, the ‘big dive’ on the US markets was followed by a huge rally the next day, so the Aussie market followed (wagging its tail). The ANZ shares took off, so that my original ‘bought’ $18.50 call option was now worth 65c. I sold for an overall profit of 78%!!
We all like to share our successes. This impressed me with the flexibility of ‘debit spreads’ – how you can turn a setback to your advantage. Options are so flexible! That is why I prefer them over other derivative instruments such as futures or CFDs.
What better way to learn option trading than by watching and listening to someone who makes a full time living out of it, choose his trades in real time, during the last hour of the Australian stock market each day.
Before you join the Planet Wealth Trading Room, you will need at least a basic understanding of the options market, including how to place a trade with your own broker.
This learning experience is invaluable, but you can access this online mentoring program for less than $US20 per hour. There are no fixed fees – you simply pay only for the hours you use.
