I don’t like buying or selling options outright. If you buy naked options you had better be right and be right pretty darn quickly because time is absolutely your worst enemy. The 100 call and/or put are still worthless when the stock expires at 100.
And selling options naked is a suicide wish. All you can make is the premium received and your risk is unlimited. No thanks.
That makes me an option spreader. You will see that almost every strategy I explain here is an options spread. The only exception to that being the cash covered short put (see my column on 10/14/13). And even then, I prefer to turn it into a diagonal spread.
So, let’s review by discussing that most simple of option spreads, the vertical. Same month options, vertically in ascending or descending order. Let’s use a put vertical.
A long put vertical spread is buying a higher strike put and selling a lower strike put. It is a bearish strategy and you want to set the target price at your short put.
Let’s say that you believe (as I do) that this long rally will end in tears as Trump continues to blow up the existing world order and start a trade war that no country can win.
As I am currently in the Netherlands and the US market isn’t open yet I will use yesterday’s SPY prices as an example. One could have purchased the July 275 put at 2.30 and at the same time sold the July 265 put at .80. We call this buying the 275-265 vertical put spread for a 1.50 debit, or $150 spent per spread. This 1.50 is the most you can lose on the trade if SPY expires higher than 275 on the third Friday of July. If, however, SPY is lower than 265 on expiration then the spread is worth the difference between the two strikes, ie, 10. In that case you make $850 per spread (10-1.50)
Therefore, we can see here that a vertical spread is a simple way of expressing your view on a stock or index with a well defined risk and reward.