Hi, hope everyone is doing well.
I just spent the day learning a little beyond the total basics of trading options, which i've been trading of a mixture of fundamental/technical analysis for the past few months to fair success. I learned how to manage and trade a vertical spread, and I will commit this to memory and hopefully elucidate the process for some others with this post.
Essentially, a vertical spread entails selling an OTM call or put and buying one that is farther OTM than the one you sold. Basically, you collect a premium for the option you sell, and protect yourself by buying another in the case that the stock price goes ITM (OTM/ITM are in the money and out the money, which basically mean the option has value because the owner has the ability to buy/sell a stock for less/more than it's worth).
There are 3 scenarios that come from this, and i'll explain with easy numbers. I'll say you sold a $100 call for $3 and bought a $105 dollar call for $1. The current stock price is $95, and IPV is worthwhile (implied volatility, which makes options worth more because theres a chance the stock price can move to a strike price).
Both options expire OTM. You lose $100 from the option you bought, and make $300 from the one you sold. $200's up.
The stock goes wild and both options are ITM. The maximum loss you can take is based on the spread between how much you bought and sold the calls for, and the values of the options. Say the price hits 110. You make $200 from the spread, you lose $1000 from the option you sold, and make $500 from the one you bought. Total down is $300.
The price of the stock is in between the strikes. Say it is $103. You make $200 from the spread, and lose $300 off the option you sold. Loss is $100. (you can play with these numbers and make a gain from an in between strike, try it!)
So, as you can see, vertical spreads are simple enough for even a UT student to understand (i'm serious, we are really just a bunch of sheep). Of course, it's worth the time to learn a little bit more about. If you can though, you stand to go to battle with the options market with a pretty sturdy shield.
So thanks for reading, let me know if you have any questions and i'd love to chat. Austin, Texas has been pretty lonely with summer around. :(
- Both options