BTO = Buy to Open BTC = Buy to Close
STO = Sell to Open STC = Sell to Close
Each Options contract = 100 shares
Call Spread – When you anticipate the stock price will rise in today’s stock market
On February 6, 2011, XYZ Company closed at $44.82. If you wanted to buy 100 shares of XYZ because you felt the stock price will continue to rise, it would cost you $4,482.00 (100 shares x $44.82). You could accomplish the same goal using options but at a greatly reduced cost.
You could buy 10 contracts (1000 shares) of the July 45 call (trading at $2.87 bid / $2.92 ask), a debit and sell 10 contracts (1000 shares) of the July 50 call (trading at $.96 bid / $1.00 ask), a credit. The difference would be $1.91 (2.87 - .96) bid and $1.92 (2.92 – 1.00) ask with 157 days to profit. If you placed an order at a limit price of $1.90, the call spread would cost $1900 instead of $4,482.
BTO 10 XYZ Jul 45 call & STO 10 XYZ Jul 50 call for $1.90 = $1900 (debit)
You would have the difference of $2,582 ($4482 – $1900) to invest in other stocks or options. Instead of putting all your eggs in one basket, you have accomplished the same goal (1000 shares) but have money left to invest in other stocks or options and thus minimized your losses.
If the call spread option price rises $.50 to $2.40, you could close the call spread as a unit for a profit of $500 (credit of $2400 – debit of $1900).
STC 10 XYZ Jul 45 call & BTC 10 XYZ Jul 50 call for $2.40 = $2400 (credit)
If the stock price of XYZ drops after the trade, you could buy back the July 50, one leg, for a lower price then you received which is a profit. Then wait for the stock price to correct (rise) and then sell the July 45, the other leg, for more than you paid for a profit on both legs before mid July.
If you choose to close the call spread one leg at a time instead of as a unit, always close your biggest liability first. In this example, it would be the leg that you sold which is the July 50 call.
Remember - Always buy enough time for your options trading strategy to work and use price alerts.
Bob has been an active trader in options since 1982 and is the President of Sweet Dreams Trading Company. Visit www.sweetdreamstradingcompany.com for more information.
All examples exclude fees and commissions
OPTIONS TRADING STRATEGY: