29 lines
2.0 KiB
Plaintext
29 lines
2.0 KiB
Plaintext
A credit spread is commonly traded as an income-generating strategy. The
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idea is simple: sell the option closer-to-the-money and buy the more out-of-
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the-money (OTM) option—that is, sell volatility—and profit from
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nonmovement (above a certain point). In this example, with Apple at $391,
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a neutral to slightly bearish trader would think about selling this spread at
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4.40 in hopes that the stock will remain below $395 until expiration. The
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best-case scenario is that the stock is below $395 at expiration and both
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options expire, resulting in a $4.40-per-share profit.
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The strategy profits as long as Apple is under its break-even price,
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$399.40, at expiration. But this is not so much a bearish strategy as it is a
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nonbullish strategy. The maximum gain with a credit spread is the premium
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received, in this case $4.40 per share. Traders who thought AAPL was
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going to decline sharply would short it or buy a put. If they thought it would
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rise sharply, they’d use another strategy.
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From a greek perspective, when the trade is executed it’s very close to its
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highest theta price point—the 395 short strike price. This position
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theoretically collects $0.90 a day with Apple at around $395. As time
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passes, that theta rises. The key is that the stock remains at around $395
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until the short option is just about worthless. The name of the game is sit
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and wait.
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Although the delta is negative, traders trading this spread to generate
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income want the spread to expire worthless so they can pocket the $4.40 per
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share. If Apple declines, profits will be made on delta, and theta profits will
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be foregone later. All that matters is the break-even point. Essentially, the
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idea is to sell a naked call with a maximum potential loss. Sell the 395s and
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buy the 405s for protection.
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If the underlying decreases enough in the short term and significant
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profits from delta materialize, it is logical to consider closing the spread
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early. But it often makes more sense to close part of the spread. Consider |