November 2, 2008
Example of a Bull Call Spread
Written on 15th February 2008 (see below for further updates)
I thought I’d provide an example of a Bull Call Spread (BCS) using the Commonwealth Bank as an example. There is a lot of volatility in the market at the moment. If you have studied my course then you will know that high volatility is a great advantage for the Option Seller – a decrease in implied volatility means a decrease in the Option premium – but let’s get back to this example!
Since making a high around $62.00 in November 2007 CBA has spent the last few months falling to its current price of $47.00. Can it go lower? Is this the bottom? I have no idea! Instead of buying the stock and watching it plummet even lower let’s look at a strategy where we know EXACTLY what our MAXIMUM risk and MAXIMIM profit is – a Bull Call Spread.
When you BUY a CALL Option your view is that the underlying Stock will rise. So with CBA closing last night (14th Feb) at $47.05 you might to decide to BUY a CALL Option with a Strike price of $48.00 that expires on the 27th March 2008. The quoted price for this option is $1.69. If you bought 2 contracts it would cost you 2,000 @ $1.69 = $3,380 (plus brokerage). In 10 days time if the stock price increased by 4% to $48.93 the Option price would be somewhere around $2.15. You could then Sell the CALL Option and profit $920 or around 27%.
To reduce the cost of Buying the CALL Option you can SELL a CALL Option at a higher strike price. Building on the above example you would SELL 2 March CALL Options at a strike price of $51.00 and receive a premium of $0.71 which means you receive 2,000 @ $0.71 = $1,420. So your total cost would be the price that you paid for the contracts that you bought ($3,380) less the money that you received for the Options you sold ($1,420). Total Cost $1,960.
The advantage is that you are reducing the cost of entering the trade. The disadvantage is that you are limiting your profit to the upside if CBA trades above $51.00. I like the Bull Call Spread trade because you know your maximum profit and maximum loss before you enter the trade. The best way to view this is via a picture (listed on the next page).
Please note that this trade is purely for educational purposes only. I’ll send an update of this trade in a week or two to see how it would be progressing. If you have any questions you are more than welcome to send me an email glenn@optiontrader.com.au.
Cheers
Glenn Dove
www.optiontrader.com.au
Update written on 22nd February 2008
It’s always worth reviewing your trades especially when you trade Options. One week ago I provided an example of a Bull Call Spread Option strategy on CBA shares. At the time of the Option trade CBA was trading @ $47.05 and we had entered a long position.
How would we be going on the 22nd February with the price of CBA trading at $42.40?
The trade has not gone in the direction that we wanted but there’s a lot we can learn from this type of strategy. The Bull Call Spread (BCS) that we entered entitled us to Buy 2,000 CBA shares @ 48.00 and to sell 2,000 CBA shares at a maximum price of $51.00 anytime before 27th March. The total cost of the BCS position was $1,960.
So what’s so good about that?
• We are in control of $96,000 of CBA shares (2,000 @ $48.00) and it only cost us $1,960 to enter the trade. This works out to around 2% of the total trade value.
• We are limited to a maximum loss of the premium that we paid $1,960. If we had of bought 2,000 CBA shares at the market price (on 15/2) we would have paid $94,100. With the current price of CBA at $42.40 we would be sitting on a paper loss of $9,300.
So as you can see even though the trade has not gone in the direction that we wanted the BCS has provided great leverage while limiting our loss potential to only 2% of the trade value. Also remember that we still have until 27th March for this trade to work. You could also decide to close the position if you thought that the CBA had no chance of getting back above $49.00 by the 27th March which would leave you with a loss of $1,297.
It’s also worth mentioning some of the disadvantages even though I believe the advantages far outweigh the disadvantages:
• If there are any dividends payable during the Option period we are not entitled to them (as we don’t really own any shares)
• We have a limited time (until the Option expiry date) for the trade to become profitable. Once the contracts expire they become worthless.
• Our profit potential is limited due to the fact that we SOLD Option contracts to reduce the cost of the Options that we bought.
If you have any questions send me an email: glenn@optiontrader.com.au
Cheers
Glenn Dove
www.optiontrader.com.au
By: Glenn Dove
About the Author:
I thought I’d provide an example of a Bull Call Spread (BCS) using the Commonwealth Bank as an example. There is a lot of volatility in the market at the moment. If you have studied my course then you will know that high volatility is a great advantage for the Option Seller – a decrease in implied volatility means a decrease in the Option premium – but let’s get back to this example!
Since making a high around $62.00 in November 2007 CBA has spent the last few months falling to its current price of $47.00. Can it go lower? Is this the bottom? I have no idea! Instead of buying the stock and watching it plummet even lower let’s look at a strategy where we know EXACTLY what our MAXIMUM risk and MAXIMIM profit is – a Bull Call Spread.
When you BUY a CALL Option your view is that the underlying Stock will rise. So with CBA closing last night (14th Feb) at $47.05 you might to decide to BUY a CALL Option with a Strike price of $48.00 that expires on the 27th March 2008. The quoted price for this option is $1.69. If you bought 2 contracts it would cost you 2,000 @ $1.69 = $3,380 (plus brokerage). In 10 days time if the stock price increased by 4% to $48.93 the Option price would be somewhere around $2.15. You could then Sell the CALL Option and profit $920 or around 27%.
To reduce the cost of Buying the CALL Option you can SELL a CALL Option at a higher strike price. Building on the above example you would SELL 2 March CALL Options at a strike price of $51.00 and receive a premium of $0.71 which means you receive 2,000 @ $0.71 = $1,420. So your total cost would be the price that you paid for the contracts that you bought ($3,380) less the money that you received for the Options you sold ($1,420). Total Cost $1,960.
The advantage is that you are reducing the cost of entering the trade. The disadvantage is that you are limiting your profit to the upside if CBA trades above $51.00. I like the Bull Call Spread trade because you know your maximum profit and maximum loss before you enter the trade. The best way to view this is via a picture (listed on the next page).
Please note that this trade is purely for educational purposes only. I’ll send an update of this trade in a week or two to see how it would be progressing. If you have any questions you are more than welcome to send me an email glenn@optiontrader.com.au.
Cheers
Glenn Dove
www.optiontrader.com.au
Update written on 22nd February 2008
It’s always worth reviewing your trades especially when you trade Options. One week ago I provided an example of a Bull Call Spread Option strategy on CBA shares. At the time of the Option trade CBA was trading @ $47.05 and we had entered a long position.
How would we be going on the 22nd February with the price of CBA trading at $42.40?
The trade has not gone in the direction that we wanted but there’s a lot we can learn from this type of strategy. The Bull Call Spread (BCS) that we entered entitled us to Buy 2,000 CBA shares @ 48.00 and to sell 2,000 CBA shares at a maximum price of $51.00 anytime before 27th March. The total cost of the BCS position was $1,960.
So what’s so good about that?
• We are in control of $96,000 of CBA shares (2,000 @ $48.00) and it only cost us $1,960 to enter the trade. This works out to around 2% of the total trade value.
• We are limited to a maximum loss of the premium that we paid $1,960. If we had of bought 2,000 CBA shares at the market price (on 15/2) we would have paid $94,100. With the current price of CBA at $42.40 we would be sitting on a paper loss of $9,300.
So as you can see even though the trade has not gone in the direction that we wanted the BCS has provided great leverage while limiting our loss potential to only 2% of the trade value. Also remember that we still have until 27th March for this trade to work. You could also decide to close the position if you thought that the CBA had no chance of getting back above $49.00 by the 27th March which would leave you with a loss of $1,297.
It’s also worth mentioning some of the disadvantages even though I believe the advantages far outweigh the disadvantages:
• If there are any dividends payable during the Option period we are not entitled to them (as we don’t really own any shares)
• We have a limited time (until the Option expiry date) for the trade to become profitable. Once the contracts expire they become worthless.
• Our profit potential is limited due to the fact that we SOLD Option contracts to reduce the cost of the Options that we bought.
If you have any questions send me an email: glenn@optiontrader.com.au
Cheers
Glenn Dove
www.optiontrader.com.au
By: Glenn Dove
About the Author:
I mainly trade Options for up to 2 month periods against stocks held on the Australian Stock Exchange. I also do some Option Commodity trading
Filed under Investing by Administrator
October 11, 2008
Forex Trading - a Guide to Pips and Spread in Online Forex Trading
The first thing you must understand in forex trading is the spread and the pips. Each currency is traded against another one. This is called a currency pair. An example for a popular pair with high daily trading volume is EUR/USD.
The EUR/USD exchange rate is one of the most traded contracts in the world. In total the forex market trades around $2 trillion Dollars every day but there are only a few currency pairs that are traded with high volume.
When you want to trade this pair then you need to know the spread and the value of a pip. The spread is the difference of the buy and sell price. For example you want to buy the Euro against the Dollar. The current price that your trading platform displays is 1.5000 x 1.5003. That means there are 3 pips spread.
You can buy the Euro at 1.5003 but sell it only at 1.5000 right now. The price of the currency pair is constantly changing. The spread can also change. The spread will get bigger with more market activity for example. Your broker is the one who earns the spread. He widens the spread when he has more risk and reduces the spread when the risk for the broker becomes smaller.
You have no other choice than paying the spread. There are brokers that offer zero spread trading but that is often an illusion. The broker makes the pricing and he can give you any price he wants. The price you see may have no spread but you can be sure that you pay a price for it some way.
Other popular currency pairs are GBP/USD, USD/JPY and CHF/USD. Your trading platform may have dozens of pairs available but do not forget that only the major currencies provide enough volume and volatility for day trades.
By: Nelson Woolwine
About the Author:
The EUR/USD exchange rate is one of the most traded contracts in the world. In total the forex market trades around $2 trillion Dollars every day but there are only a few currency pairs that are traded with high volume.
When you want to trade this pair then you need to know the spread and the value of a pip. The spread is the difference of the buy and sell price. For example you want to buy the Euro against the Dollar. The current price that your trading platform displays is 1.5000 x 1.5003. That means there are 3 pips spread.
You can buy the Euro at 1.5003 but sell it only at 1.5000 right now. The price of the currency pair is constantly changing. The spread can also change. The spread will get bigger with more market activity for example. Your broker is the one who earns the spread. He widens the spread when he has more risk and reduces the spread when the risk for the broker becomes smaller.
You have no other choice than paying the spread. There are brokers that offer zero spread trading but that is often an illusion. The broker makes the pricing and he can give you any price he wants. The price you see may have no spread but you can be sure that you pay a price for it some way.
Other popular currency pairs are GBP/USD, USD/JPY and CHF/USD. Your trading platform may have dozens of pairs available but do not forget that only the major currencies provide enough volume and volatility for day trades.
By: Nelson Woolwine
About the Author:
Highly Recommended Reading:
Click on one of the links above to download Nelson Woolwine’s new and FREE Forex e-book.
Filed under Currency Trading by Administrator
October 9, 2008
Financial Spread Betting - Today’s Scenario
You should be able to find several indispensable facts about financial spread betting in the following paragraphs. If there’s at least one fact you didn’t know before, imagine the difference it might make.
There was a time when financial spread betting was just a way to “punt” on the financial markets, purely a gambling product with wide spreads and odds firmly in the bookmaker’s favour.
What really shifted opinion was the introduction of more transparent pricing. Spread betting companies recognised that spread betting was a cheap, flexible way to play the financial markets, but the instruments remained bound by pricing associated with betting. The true evolution of spread betting occurred with the introduction of more transparent pricing, allowing retail investors to make judgments based on the cash market price in common with the physical trading of shares or contracts for difference (CFDs). This coupled with more competitive dealing spreads, means betting on the financial markets has become a serious way to trade.
Many people are using spread betting as their initiation to the financial markets. Many say spread betting offers much more for much less. Of course spread betting is best suited to short to medium- term trading strategies, but rolling cash and daily bets mean spread betting should be included as a weapon in the armoury of any investor, whether for speculation or risk management.
Daily spread bets and rolling cash bets have been introduced by a number of the spread betting companies. Bets of these types offer a product based upon the underlying cash price rather than the traditional futures price, allowing traders to relate prices to the tangible cash market.
There are two good reasons why you should consider technical analysis.
1. ‘Buy and hold’ is dead
In the past you could go long of any shares and eventually, if you waited long enough, you would likely profit. That’s no longer the case.
How can you put a limit on learning more? The next section may contain that one little bit of wisdom that changes everything.
2. Brokers were simply following the trend
Brokers’ buy notes and tips in old times were correct, not because of their analysis, but because of the up trend of the market. Now the trend has changed and the shortcomings of fundamental research is being revealed. Chartists are now credited with predicting the bear market - and how long it will last.
The problem that has been highlighted in a bear market is that much of the financial world is geared to markets going up and has a vested interest in them doing so. There are only two main groups that are not bothered whether this is happening or not: chartists and spread betters. Chartists are only really concerned with being seen to predict the markets correcting and spread betters are happy as long as it moves enough for them to trade quickly and successfully.
Traders no longer use spread betting simply for speculation. Its flexibility makes it ideal for hedging and particularly useful with sophisticated strategies such as pairs trading. Traders with a significant share portfolio are turning to spread betting when market prices are going down to lock in profit. Having pricing closer to the underlying cash price and competitive spreads is vital to ensure hedging is effective in achieving a market neutral position.
Trading strategies that have become increasingly popular are pairs trades on both individual shares and indices. A pairs trade usually compares the performance of one share against another linked share. For example they are in the same industry.
Many people are using spreadbetting as their initiation to the financial markets. Many say spread betting offers much more for much less. Of course spread betting is best suited to short to medium- term trading strategies, but rolling cash and daily bets mean spread betting should be included as a weapon in the armoury of any investor, whether for speculation or risk management.
This article’s coverage of the information is as complete as it can be today. But you should always leave open the possibility that future research could uncover new facts.
By: Jayant Patil
About the Author:
There was a time when financial spread betting was just a way to “punt” on the financial markets, purely a gambling product with wide spreads and odds firmly in the bookmaker’s favour.
What really shifted opinion was the introduction of more transparent pricing. Spread betting companies recognised that spread betting was a cheap, flexible way to play the financial markets, but the instruments remained bound by pricing associated with betting. The true evolution of spread betting occurred with the introduction of more transparent pricing, allowing retail investors to make judgments based on the cash market price in common with the physical trading of shares or contracts for difference (CFDs). This coupled with more competitive dealing spreads, means betting on the financial markets has become a serious way to trade.
Many people are using spread betting as their initiation to the financial markets. Many say spread betting offers much more for much less. Of course spread betting is best suited to short to medium- term trading strategies, but rolling cash and daily bets mean spread betting should be included as a weapon in the armoury of any investor, whether for speculation or risk management.
Daily spread bets and rolling cash bets have been introduced by a number of the spread betting companies. Bets of these types offer a product based upon the underlying cash price rather than the traditional futures price, allowing traders to relate prices to the tangible cash market.
There are two good reasons why you should consider technical analysis.
1. ‘Buy and hold’ is dead
In the past you could go long of any shares and eventually, if you waited long enough, you would likely profit. That’s no longer the case.
How can you put a limit on learning more? The next section may contain that one little bit of wisdom that changes everything.
2. Brokers were simply following the trend
Brokers’ buy notes and tips in old times were correct, not because of their analysis, but because of the up trend of the market. Now the trend has changed and the shortcomings of fundamental research is being revealed. Chartists are now credited with predicting the bear market - and how long it will last.
The problem that has been highlighted in a bear market is that much of the financial world is geared to markets going up and has a vested interest in them doing so. There are only two main groups that are not bothered whether this is happening or not: chartists and spread betters. Chartists are only really concerned with being seen to predict the markets correcting and spread betters are happy as long as it moves enough for them to trade quickly and successfully.
Traders no longer use spread betting simply for speculation. Its flexibility makes it ideal for hedging and particularly useful with sophisticated strategies such as pairs trading. Traders with a significant share portfolio are turning to spread betting when market prices are going down to lock in profit. Having pricing closer to the underlying cash price and competitive spreads is vital to ensure hedging is effective in achieving a market neutral position.
Trading strategies that have become increasingly popular are pairs trades on both individual shares and indices. A pairs trade usually compares the performance of one share against another linked share. For example they are in the same industry.
Many people are using spreadbetting as their initiation to the financial markets. Many say spread betting offers much more for much less. Of course spread betting is best suited to short to medium- term trading strategies, but rolling cash and daily bets mean spread betting should be included as a weapon in the armoury of any investor, whether for speculation or risk management.
This article’s coverage of the information is as complete as it can be today. But you should always leave open the possibility that future research could uncover new facts.
By: Jayant Patil
About the Author:
Jayant Patil is a well-known investment consultant. He has been in this field since last 20 years and has advised on ethical practices to become wealthy. For updated information, reviews, videos, blogs please visit http://www.sharetradingguide.com/SpreadBetting
Filed under Wealth Building by Administrator
October 7, 2008
Credit Option Spreads
What is a credit spread?
Investopedia says… “An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.”
OK I know that is very vague, so lets see if I can do better.
It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the stock does not go past the sold strike price at the end of expiration you will receive a full credit winning trade.
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will increase in price over the next month and you firmly believe that the stock will not go below $50. You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for $.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your account or actually $75 per contract you trade. The risk of the trade or the amount of money per contract you need in your account is $425 per contract. This gives you a return on investment of 17.5% in how ever many days till Feb expiration.
Lets take it out like a real trade - It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or $500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you will lose $2125.
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed, and exactly how much money you will risk then credit option spread trading is for you. Your profit margins will be between 10 and 20% on each trade - on some of the aggressive credit spreads you can make over 50% - and there are techniques for changing your trade if it becomes a losing trade to help you recover some of the loss and in some cases even make it a winning trade again even though you were wrong on the direction of the movement of the stock.
By: Daniel Beatty
About the Author:
Investopedia says… “An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.”
OK I know that is very vague, so lets see if I can do better.
It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the stock does not go past the sold strike price at the end of expiration you will receive a full credit winning trade.
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will increase in price over the next month and you firmly believe that the stock will not go below $50. You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for $.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your account or actually $75 per contract you trade. The risk of the trade or the amount of money per contract you need in your account is $425 per contract. This gives you a return on investment of 17.5% in how ever many days till Feb expiration.
Lets take it out like a real trade - It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or $500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you will lose $2125.
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed, and exactly how much money you will risk then credit option spread trading is for you. Your profit margins will be between 10 and 20% on each trade - on some of the aggressive credit spreads you can make over 50% - and there are techniques for changing your trade if it becomes a losing trade to help you recover some of the loss and in some cases even make it a winning trade again even though you were wrong on the direction of the movement of the stock.
By: Daniel Beatty
About the Author:
Daniel Beatty has been trading options for several years and now teaches others how to trade specific strategies for free through his website http://creditoptionspreads.com or Option Spreads.
Filed under Finance by Administrator