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Stocks & Commodities V. 31:2 (40-41): Explore Your Options by Price Headley
Stocks & Commodities V. 31:2 (40-41): Explore Your Options by Price Headley
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Explore Your Options by Price Headley
ABOUT CREDIT SPREADS
How does a credit spread work?
There are several types of spreads, but they all work similarly. Option spreads can be used to take a bearish, bullish, or neutral position. For example, lets look at a credit spread, which is what a spread is called when it generates a net inflow of cash into your account.
In this instance, we are bearish; according to our calculations, we think the price of XYZ stock will go down. We decide to sell a September 30 call for a price of $3. Since we think that XYZ will go down in price, we assume that nobody will want to exercise our short call against us that is, make us sell them XYZ shares at $30 since they can be bought in the open market for less than $30.
However, to protect ourselves in case we are wrong (in case XYZ shares increase in value), we buy a September 35 call at a price of $1. That way, if XYZ shares go to $40, we can get someone else to sell their shares to us at $35, and we can cap our risk at the $5 difference. Our real maximum risk is the $5 difference minus the credit collected. Take a look at our position in Figure 1.
ABOUT CREDIT SPREADS
How does a credit spread work?
There are several types of spreads, but they all work similarly. Option spreads can be used to take a bearish, bullish, or neutral position. For example, lets look at a credit spread, which is what a spread is called when it generates a net inflow of cash into your account.
In this instance, we are bearish; according to our calculations, we think the price of XYZ stock will go down. We decide to sell a September 30 call for a price of $3. Since we think that XYZ will go down in price, we assume that nobody will want to exercise our short call against us that is, make us sell them XYZ shares at $30 since they can be bought in the open market for less than $30.
However, to protect ourselves in case we are wrong (in case XYZ shares increase in value), we buy a September 35 call at a price of $1. That way, if XYZ shares go to $40, we can get someone else to sell their shares to us at $35, and we can cap our risk at the $5 difference. Our real maximum risk is the $5 difference minus the credit collected. Take a look at our position in Figure 1.
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