Trading Vertical Spreads | Short Put Verticals | 5-1-19
Good. Afternoon. And welcome everyone my name is Cameron, May I'm filling in for John McNichol today we're, gonna be spending 45. Minutes, together discussing. Trading. Vertical, spreads and today our topic is, short. Put verticals, looking very much forward to, it I actually teach, classes. On a regular basis, on options trading, if you'd, like to join me on Thursday morning or Friday morning, Thursdays we have a class called selecting, an option strategy, or certainly invited to join me there or managing. An options, portfolio, on Friday mornings, that's more in an advanced, level but. I'd love to see all of you there as well but, let's try to get the most out of our time together the first thing that I always do it's a tradition a tradition for, me but I think it's deserved is to, welcome those returning, veterans who come every time, come week after week hello there Remmy hello. Michele welcome, Elda and rich and everyone else that comes back over and over again we, definitely appreciate your attendance and also your contributions. I think that your veteran insights into some of these strategies can really help those that are on the front end of their learning curve help. Fill in some of those gaps as they're making their own way along. Their own learning, trajectory, so if. You are checking out today's webcast for the very first time I want to welcome you as well I actually. Will, be filling in for John McNichol for, most of the next two months. So. I'm. Looking forward to that so. We'll just call this I'll be the regular for a little while although, for a couple, of weeks at the end of that, maybe three weeks the, end of May and June, I'll be, out as well I'm. Going to be heading off to Scotland, so if you have any great ideas for, what to do there. Elda. Do we have this event in Spanish, - I don't believe, so Aldo. Although I might have to check into what sort of this week's you might be able to make to your to. Your settings, on YouTube or something like that I'm not, sure anyway, but. Let's, get to it first, thing we need to do is consider the risks associated are investing, and then we'll set an agenda for the day and then we'll get right to the concepts. So. Some, important information. Options. Are not suitable for all investors spread. Straddles and other multi-lane option strategies can entail, transaction. Costs past. Performance, of any security or strategy is not guarantee future results for, success any. Investment, decision you make in your self-directed account, is solely your responsibility, here's. An overview of your Greeks, we, are going to be using real examples, in today's discussion please, don't take that as a recommendation or endorsement, of any securities, or strategies discussed and the, usage of a stop order is not a guarantee they will buy or sell at a specific price, alright. So here's the agenda for, today, we're. Going to be accomplishing. Five bullet, point items first, we'll identify potential. Entry, signals, we'll. Talk through a strike. Price and expiration, selection. On short, put verticals, and I, have some to. Illustrate, these concepts, will talk about them theoretically, and then apply, look. At Theory application Theory. Application that's, going to be the rhythm. Once. We've established, some. Example. Entries, some example strike and expressive. Selection we'll take it an example trade and break, it down for its max gain its max loss its. Return. On risk and then. We'll talk about when a trader. Might exit, a short, put vertical and. Finally. We'll wrap it up by actually placing, a trade so, that we're trying to connect as many dots as we can so. That through the accomplishment, of these five agenda. Items the, next time you go to place a short put vertical in your paper money or getting some practice you'll, know the resources, that are available and you'll know at least some processes. That can be pursued in in. The trading of this strategy alright, and. Now oh a Dwayne did I say hello to you good, afternoon lane great to have you here, but. Let's talk about potential, entry signals a short put vertical is, classified. As a bullish. Option. Strategy, so what we're going to be typically looking for is a bullish, entry signal now as I go into this discussion of short put vertical so I'm going to be doing this at kind of an intermediate. Level so. If you need to take a step back to the basics, of the. Construction, of vertical spreads the pros and the cons and all that sort of a thing I'll try to cover as much as I can but, it may be helpful to go check out barb Armstrong's, class on Friday mornings, it's at 11 o'clock Eastern.
Standard Time matter, of fact it directly, dovetails, with and immediately follows, my. Class on managing an options portfolio, but Barb's class and getting started with options trading, 11. O'clock Eastern Standard Time you might want to check that out Thank You there Ricardo. Okay. But what are some potential bullish, entry, signals without spending, too much time, on the. Topic one, potential entry signal is when you are anticipating. A bounce a bounce is when you see a price that has fallen down conceptually. Down to maybe a price floor or. What, we call a support level and you, think it's going to bounce up, so. How do we anticipate the bounce well a trader might look for a bullish, candle pattern that's, right near, a potential. Support level so here's a hypothetical, support. Level you can see price is pulled down a little bit and in this case we have a specific, price pattern, or Department candlestick pattern that's, called a hammer let's. Go see that in real life this is not an example of a hammer but just bullishness at support. On. Our thinkorswim, platform if, you look at symbol te L, this. Is an SP 500 company, you. Can see that recently, there. Was a strong reaction to an earnings announcement, and then. Some price retracement. Taking it back down to previous. High as you can see this was a price ceiling historically. And then. What did we get yesterday, there's, a big bullish candle and it. Is a specific price. Or. Candle. Pattern can anybody, identify, what that might be for me a big. White candle, looks like it could gin here's a hint it could just swallow up this, candle, just to the left of it so. That's what we would call a bullish, engulfing pattern. Now. Some of you might be tempted to say yeah Cameron it's also a balanced pattern it's actually not a bounce pattern, at least as defined, as a k-hole dorsi a hol D we're. Going to talk about those in just a second but, that would require a close above, the high of the low day and in, this case this. White. Candle, is the, low day you. Can see that it stuck its little tail down the furthest so as price, was pulling back. Yesterday's. Candle. Included. The the short-term, low so. We need for, a true K hole entry a close, above yesterday's candle. But. In any case yeah there's a an example of a, bullish, candle at. A, support, level all right what's another potential, entry signal entry. Signal number two. Trading, the bounce as it actually happens and this is where you're looking for that close above the high of the low day you, look for a stock that trades above, the high of the, low day and if you haven't seen that before I'll show you an example and. You may. Want to determine for yourself what. Time of day you would like to activate your order so we're talking about, a. Day. Or. Technical. Development, where you've been watching a stock pulling down for maybe a few days it. Hits a low and then. You noticed intraday. So, during trading price, is pushed up above, the. High point of that low day, so. Without waiting for the close without waiting for confirmation let's, say the next day you. Trade the bounce as it, happens so, are there any bounces, that are happening out there on.
In. Real time let's go have a look. Going. To our paper money how about we look at symbol, like, DW. So. Here it's Edwards, Lifesciences this. One's working on it it's trying, but. You can see that price has fallen in recent weeks it's. Taken us right down to a trendline here's, our potential, support level right, through here and you can, see if i zoom in, a little bit, on. This most recent activity. Here's. What you might call the low day. That's. The the candle that just pointed that pushed, down the farthest, as we've been pulling down so. We're looking for a close above. The highest point of that low day so here's. Where a technician, might turn their attention, to this level right there. The. High from. That low day was. 176, 25 look. Where we are right now as, we, move into the final hour of trading today, 176. 28, so, three cents, above that high yesterday. We came close but didn't get that close above, the high of the low day so there. Is an example of maybe, a bounce that's in the. Works. Okay. One. Other potential, example. May. Be we look at something like DLR. Here. We have a very similar, trend, making. Higher lows making. Higher highs we. Pulled back over the course the last couple of weeks as i. Zoom in here I can see that just a few days ago here's, our low day and this one's a much more prominent, low right, this. One. Comparatively. More apparent, on the chart, so, what we're looking for in a subsequent day is a. Closing. Price above, the high of, that. Low day and, a look at where we are right now, the. High of that day. $118. Exactly. Right. Now we're, at 118, 14. So a fair, chance that we. Are pointing, toward a confirmed. Bounce. But. A trader may not wait for the confirmation maybe, they just place the trade during the day and you might have to determine for yourself is it gonna be two hours before the close is it, gonna be if you hit any point, above. That high. That's. Up to you but what's. A final entry signal. Final. Entry signal is when. You get a confirmation of, the bounce this is where the stock actually, closes. Above the high of the low day or you're. Just very close to the end of the day maybe within 30 minutes or so, okay. So. An. Example. Of that may. Be a, stock. Like Oh. Sky. Works I think was getting ahead, of recent confirmation, yeah there we go there's, an upward trend in stock that pulled, down to a recent, support. You. Can see this old high. Old. Resistance. Acting as a new price floor there's, our load a didn't. Get a confirmed.
Bounce The. Day after but. Yesterday, there's, a close a close above the high of the low day so, might say all right so. We. Got the confirmed, the. Confirmed entry and, maybe we take the trade the next day and in this case we had a gap up and a continuation, of bullishness today although, there we've surrendered some of that some, of those gains, another. Example might be like FedEx. FedEx. Let's zoom in. Actually. Let, me keep this, much activity here because. You can see a previous. Price. Ceiling. Acting. As a potential, new price floor see. How prices, for the four boy. Really, the, vast majority of the time through these several months remain. Below about that one eighty four level and then we pushed up and threw on a big white candle, day and then, that previous. Price, ceiling, looks like it might be acting as a new price floor, there's, our load a and if, we didn't get a confirmation on this day we, certainly did yesterday. Right, so. Those are three, examples of, potential entry signals so, whether you're buying just on a bullish candle at support, you're buying on just, a break and a parent developing. Balance or a confirmed, bounce. Where. Do we move from there let's talk in let's talk about, strike. And. Expiration. Selection. Now. About for the rest of our discussion. Let's just stay with FedEx, since it was there among our list of potential, candidates. Okay. So. Here's our strike prices and expiration, so. Technicians often select a strike price that's below as many. Levels of potential, support as possible while. Maintaining minimum. Acceptable, premiums. What does that mean well so if you see a price floor let's say price is here and a price floor is way down below. It. Might be interesting to select a price a, strike. To sell to begin the construction of your credit, spread or, your short put spread. Down. Below that distant. Support, but, what kind of credits are you're likely to collect under, those scenarios where you're way. Way out of the money probably. A very, low credit, and in that case the, transaction. Fees may, wipe out a big portion maybe I don't know even all, the potential, gains on the trade so. For some investors they'll, set what they consider to be an acceptable, minimum, now that's again going to be up to you and I think you'll develop that, is you practicing your paper money. But. Some traders. Select strike prices and expirations, that, generate a minimum percentage return. On risk, and if you're not familiar with calculating, return on risk we'll talk about that but, also that would be another reason why you might want to revisit. Barb. Armstrong's, class on Fridays and finally. Traders. Do commonly, select, out of the money strike, prices although not always with, a short, put vertical, now. Does anybody has. Anybody ever had the impression and it does this doesn't this isn't, an embarrassing, admission or maybe you've you've, you've. Learned something and then you change your opinion on it but. But, if. You ever had, or been given the impression that, credit. Spreads have to be done exclusively. Out of the money. They. Don't have to be they, can be done at the money they, can even be done in the, money that, would be done if an, investor, is comfortable, with a low, probability trade. Where. They're convinced, that the stock is likely to continue to move in their anticipated, direction, which, would then hopefully. Drag, that in the money position, out. Of the money before expiration, and optimize the outcome of the trade that would. Be the, idea there but. For today's example let's. Go with a strike, hopefully, below our support, let's. Make let's check, on their return on risk and let's. Position this, one out of the money okay. So. Let's. Stick with FedEx we'll go to our trade tab. And. As. As, price is moving higher. How. Do we choose the expiration. Well. What would be really nice would. Be to construct, this this via terrific, combination, of, variables, on on, a vertical spread on. The credit spread like a foot spread, if. I could construct a put. Spread that's way, out of money. That. Pays a great. FAT premium, and. That. Expires three minutes from now that, would be fantastic. Is. That gonna happen, nope.
So. What we're looking for is to find a balance there's, the concept, we. Want to see how, far can we increase. The probability of success, on a trade by. Moving, it out of the money while, still collecting, and a, quote unquote acceptable. Premium. And. At. The same time maybe, attempting. To minimize the, amount of time for. The stock to have a chance to screw that trade up. So. We could look at like a 16. Day contract, 23. 37:51, as you. Go further. Out in time, here are some pros and cons. Going. Further out in time actually. Usually. Will allow you to move that strike like let's say your stock in this case FedEx. Is at 187 80 and you. And you intend to sell a put spread that's way out of the money okay. Well. The further out of time you go typically, the further you can push that put spread out of the money which is nice however. At. The same time you're also providing, more, time for. The stock to. Pursue. And overtake, that put, spread so, pros, and cons how, about for our example, today let's see if maybe we can do a 16, day trade. Alright. And. I'm, gonna come over here to our. Strikes. And, to. Construct our put I'm, going to use Delta. As a guide now Delta, has a, number of applications, one of which is. It gives you a it gives you an approximate. Likelihood, that your that, you put vertical if you put it on and leave it alone that it will succeed. Okay. So. In this case if we're. Defining success as. The. Whole thing the whole put, spread expiring, worthless, look. At our Delta somebody. Tell me what, is the mathematical likelihood. Just this and this is approximate, of course there's a possibility, it could not it, could turn out the, opposite. But. What's what's the approximate mathematical. Likelihood, that our, spread expires, worthless if, we start by selling that 185. Put, well. It has a delta of, 37. That's, the likelihood, that that put. Is in the, money to, some extended, expiration, in other words there's about a 63%. Chance that. That put spread is out of the money at expiration. Okay. So about a 63%, likelihood. Of maximum. Gain, on this trade and maybe. Just to illustrate my point when, selecting, strikes and, expirations. If you, go further out in time you'll. Typically, be able to move. Your strikes. Further out of the money as well let's. Maybe compare that to a 51-day, contract. If. We go to the 21st of June and. We look around the same, we. Don't have exactly, the same delta. You. Know but, if we're nuts in that in, that 30. Delta, range our, other one was 37, so there's a little bit of difference there and the probabilities, but. We might be able to go with a 180, foot, which, is nearly. $8 out of the money versus. Our, one 85 foot which is about $3 out of the money, there. You go no Chuck that happens to me all the time I just, get to do it in front of a lot of people on a regular basis where you miss, state what I would always say and, I'll go to this time and time again when, I say the opposite of what I mean in my classes, I think. It's very much like this it's like when I call my kids by the wrong name now. You know what I meant right, hopefully. I'll catch my error and, correct it in real time but yeah, I'll. Forgive you for that if you'll forgive me for doing it you've heard me do it before I know you have Chuck anyway, let's go back to the, 16-day. Contracts, and, let's. Build an example, trade, okay. So. We're going to start this by selling, that.
185. And. Let's be specific here the 17th, of May. 185. Put. And. It. Looks like that's trading for between 227. And 235. I'm. Gonna be a little bit not generous. Ungenerous. Stingy. And say let's say that we we. Tried to get filled at the mid-price we didn't get it and we only get two dollars and 30 cents okay. I'm. Just doing that because it's gonna get me a nice round number it makes everybody's, math simpler, and it, makes it easier to follow my, logic in this class so. That starts, the put spread, so. Now let's, go maybe a strike or two higher and you, go as high as you want to go here on the option chain this is going lower in price as you can see, but. The, further you go away from the option that you've sold the less, you're spending, on the option that you're buying so, that allows you to train and retain more of your credit but, it also increases, the spread. Within. The bid at within, the vertical. And that, increases, the risk of the trade okay but, how about we say that we go for a five dollar wide spread so let's go to the 180 and we're, gonna buy the 17th. Of May. 180. Put. How. Much is that trading for 107. To 115, all, right now I'm gonna be a little bit generous and say that we can get that for 110. Obviously. We don't know, what. We're gonna see. For, fill prices, on these until the orders actually fill but. There we go so there, is our example, vertical. Illustrating. Some of the pros and cons of strike, and expiration. Selection. So. Let's go back and, let's talk about Max, gain max loss return on risk and how. Many contracts, the trade. All. Right. So. How as, a quick recap. How. Do we calculate the maximum, gain on this, trade. Well. You take the, amount that you collected, when, you sold the option when you sold the short option and. Subtract. The. Amount that you paid to, buy the long option so. In that case what was our scenario, it. Was 230. Minus. 110 the, maximum, gain I'm gonna abbreviate, it to mg, well. Is a dollar and 20 cents that. Might not sound a lot but. We always have to put it in context, how much are we risking how much we tying up for this trade how's. That calculated. So. Maximum game is just your net credit your, maximum loss is the difference between your strike prices, -. Your credit so we had a five-dollar widespread. 185. 180, and. We. Have a net credit of $1.00 20 so what's our maximum loss. Three. Dollars and 80 cents let's go back and see that. So. Here's our 185, 180, so. Our max loss. Is. Five. Dollars. Minus. Our. Net credit of, a dollar 20. So. There's our maximum loss three, dollars and eighty cents okay, now. Right, at this point an investor. Might look at this and say well so is is, this trade making, sense for me I, know. I can make a dollar 20 if the trade works out I can, lose as much as 380 if, it doesn't so my, reward, to risk is, about. A dollar of. Potential, gain - every three dollars of potential loss that. Is not an, uncommon. Scenario, and as a matter of fact it is the expected scenario, with, an out of the money vertical, spread. So. Let's go back and and, revisit. The rest of this so our return on risk, maximum. Gain divided. Maximum, loss so. In this case a dollar 20 divided by 380. Is gonna be what right around 31. Ish percent, I just did that off the top of my head will do that more so more precisely in just a moment but. Having, calculated that an investor, would start to make the decision is this worth it, for. My convictions regarding, what's happening technically, on the chart. Isn't. Enough to justify transaction. Fees. Am. I just happy with that scenario. And. Then finally if you are then it's time to move on to determining, how many contracts, to enter so. How. Do you determine that. Well. This is where you have to take a personal, inventory of your own risk tolerance and your own accounts. Capacity. For risk okay so. Let's say you have a hundred thousand dollar account and you. Wanted to make sure that you that. You didn't risk any more than let's say 1% on. An individual, trade, so. 1%, of $100,000, would be a thousand, bucks, well, how many contracts, would this tell us to trade in this vertical spread if, we have $1,000 well, we, take four. We first need to calculate the, the, risk. Per. Contract which is the three. Dollars and 80 cents. Times. 100 is 380 dollars if. We did three contracts, that would just go slightly, above, a thousand, and you'd have to ask yourself, but am i okay with going a little bit above a thousand but. You determine, your own acceptable, risk per trade and the, number of contracts, is the risk per, trade that's. In this case 380, dollars. Divided. By well, by me that's. $1,000, the risk per trade divided. By the maximum loss on this trade which is three hundred eighty bucks let's. Go see that. Okay. So. First of our all our return on risk is. A dollar 20, divided. By 380. Let's. Get out our calculator here. Dollar. 20 divided. By 380. Yep. My set was about 31% its. 31.6%. Okay. Position. Sighs. Here's. The calculation. Risk.
Per Trade. That. In, our hypothetical scenario. That I just proposed there thousand. Bucks right. Divided. By the. The. Trade, risk or, as is expressed, here on the slide of the slide just the maximum, loss of the trade. And maximum loss here is. $380. So, that's gonna result in and I'm going to be precise again with our calculation, 1,000, bucks divided. By 380. Is. 2.6. Contracts. So. Is there going to be a decision that has to be made here. I'd. Be interested you don't have to tell me if you don't want to but. Do, you think you would round up or round down. Because. You have the, flexibility, to do both right, rounding. Up obviously, is gonna it's gonna increase, your risk to a little bit above, $1,000, if we did if, we did 300 contracts. Or three contracts. $380. Times three, is gonna make the risk about, $1100. 1140. Setting. Transaction, fees aside not. Including those in the equation, if we, did two contracts, we'd have 380, times. 2 which. Is 760, dollars, which. Keeps you below your risk threshold. But. Also if the trade goes into as as anticipated. You. Might be leaving 120. Dollars on the table that, may have been realized. Had you, done the three contracts, so there are pros and cons there so Lane says he drowned down that's okay that's, again up to the individual, investor right. How. About for. Today's, example, Lane let's, go ahead and round this down Robert saying he'd probably round it up to three yep. So. I'm. Gonna say two to three. Contracts. There. You go. So. Let's. Go, ahead and I want, to show you how to place this trade I'm not actually gonna submit, the order in my paper money account because. Actually. Maybe, I will I've, got to make a decision here because I was gonna say I'm just. Filling in for John but. We, do have I'm, gonna be here for a while right, for a couple, of months with a couple. Of weeks exception, here and there, no. I'm just gonna I'll show, you how to place a trade let's do that so, notice, as we go back to the strike chain here, as we look down through the the increments. Of the strikes. These. Two that we've selected are two, strikes, apart, there's this interloper, there this there's. This other strike, in the middle so if we come up here to spread, and we, change that to vertical, we. Don't get the right strike pairing I want. The 185, and the, 180 in order to place my trade and it's only gave me 185. 187, and a half or 185 182, and a half because. When you go up here and you set your spread to vertical, it. Pairs up each strike. Increment, with the one right after and the one right before. But. Here's what I want to do I want to skip, to. Every, of their strike and the, way you do that. Click. On spread, vertical, I'm, gonna go down to deep and wide, and, when. I saw that for the first time I didn't know what it meant either here's. What it means in. The next column that's exposed, as you pointed, that you'll, notice it gives you months and strikes, well I know that both, of my contracts, are in the same month so I'm gonna go with one month, but. They're two strikes apart, so, I'm gonna go to a one month two strike vertical. And, now watch what happens as I click on that these. Are, now paired, up in the way that I wanted. For. My trade right there's, that 180 185, foot. Vertical, and. I can click on the. Bid, price to construct, my trade now there are a number of, other ways I could, have built that order right that's, just one way I just want I like to show different, navigation. Techniques. That might be applied it. Just depends on the day on what I want to have shown more, recently. But. Now we just need to make sure that this fits what. We are seeking to do let's make sure that our quantity is correct dial. That down to 200. K. Oh Thank. You Ricardo ask the question and thank. You for calling my attention to it Frank and we, have time to address this so thank you Ricardo. Says if the short option is in the money there's, a great risk in being assigned very soon the only time I do that is with the European, expert, indices, where there is no assignment. Possible, until the last day okay so yeah here's what Ricardo's talking about when. An option goes in the money it, can be, exercised. And therefore if you're short assigned. Early, right. Now. What's the likelihood, of that happening I, can't put a number on it numbers. Are meaningless it either is going to happen to you or it won't. You. Know guesstimate. Slyke that are relatively. Meaningless but. There. Are scenarios that can it, can increase, that risk, okay. So. Frank to your question, how real, is the risk of early assign all it can certainly happen it, does happen, does. It does it happen every, time or very often. Now. The majority of options, actually are never. Exercised. Now. At expiration. In. Many, options are all exercised, unless.
They're Explicit. Directions left, by the owner with, their broker to not exercise, so. There can be rare exceptions. But. Once a once, a, contract. Hits expiration. If, it's in the money it's. Getting exercised, its getting assigned if you're short. Before. That what, are some of the scenarios that can drive up the likelihood, of early, assignment. Well. Number. One is, if. The stock goes way. In the money we're, in a case of a put way, in the money right. So. Further and the money your short option goes the, the greater the the theoretical. Likelihood, that that contract, could be assigned. Now. Even, saying that, the. Odds are still comparatively, not strong compared, to it not being exercised, okay. But it could still happen it. Could still happen so. That's one thing another, thing that increases. The likelihood of exercise, or an assignment. To. You is, that. Closer you get to expiration. Really. Both of these variables, going deep, in the money or getting closer to expiration the, thing that they're both affecting, is they're, reducing, the time value of the, option. When. An up let me ask you you veterans. If. You own an option you decide to exercise early, what, happens to that time value, you owned. That. You could have cashed out had you just sold the option instead of exercising. Let's. Say your contract, has 100 bucks and in. Time value that. Is surrendered. It's gone there, is no return, on value, on that. On that remaining. Time value so. In most scenarios, it. Is it's, a more profitable thing, at the, moment of the, trade for. A traitor. To instead, of exercising. Before, expiration. Usually. If they do the math correctly it. Makes more sense to sell. Their contract, and if, they wanted to deal with the stock to deal with the stock independently, buy it or sell it just not that market prices. Yeah. But Ricardo says you, give up any time value now a final, variable, that we're Carlos mentioning, here is if, there's an approaching, ex-dividend, date now this affects, the, likelihood, of a short call, option. Being exercised, early when, someone you sell a short call. What. What. Obligation, do you have well somebody has the right to buy shares of stock from you in or there were other words in other words you're obligated, to. Sell shares of stock at a specific price right, well. If there's a dividend, that's about to be paid let's, say you're getting fairly close to expiration, so, that risk is already going up the stock is already gone in the money that risk is already going up and now, there's. A dividend, that might be paid well. An investor, may weigh, well. Do I wait the extra few days till expiration. To. Exercise. This. Contract. But. At the cost of missing out on. On. A dividend, or if, the ex-dividend, date is approaching and it's before expiration. Of the contract they. Might decide to exercise. Their right to buy the shares from you so, the contract, is assigned, your. You're, required. To sell those shares so. The. The. Existence. Of an ex dividend date before expiration, that can raise the risk, once. Again conceptually. It. Might even still, be a better idea for most, traders, -. Instead. Of to exercise, their option to get the shares why, not just buy the shares at market prices you might think well I'm able to buy it less. Expensively, by exercising an option that's true but you're also, surrendering. The option value at that point. So. Yeah, that. I think would make an interesting discussion in one of my other classes where I can spend more time running through the math of why it usually works out to be better to not. Exercise, an option than, to exercise, but. It still happens but, that. Logic, frank explains. Why most option, contracts, or at least contributes, to the explanation, for why most option contracts, are not, exercised, before expiration, okay you're. Welcome good, question, alright, so there is our contract, right now look it's looking more like a dollar 30 for credit when, we originally calculated, it was a dollar 20 so, if that if that reward goes up on your vertical spread what happens to your risk on that trade it, comes down yep. So. We could from here submit this is a limit order or change it to a market order both of those have a pro or have pros and cons if we submit a limit order there's, we running the risk that that. The order might not fill of course, if. You submit a market order we're.
Theoretically, Increasing, the likelihood that our order fills but. We're also exposing, ourselves to market prices, and we might not be satisfied, with the net credit duration where you see them. But. For, now. I. Think what I'll do is I'll just take us to the order confirmation screen. Click. On confirm and send this is where we just double check selling, two verticals, the. 185, 180, put spread, looks. Like breakeven. - 180 360 three, maximum profit, of 274, or maximum loss of 726. This. Is a multi, leg strategy, with multiple contracts, we're multiplying the. Transaction, fees okay, and then, we'd send from here I'm not gonna send that but I wanted to show you that process, the. Final thing though when. Might you exit. One. Of these strategies let's go back to our. Slide. Deck and talk. About some example exit Trikke criteria, well. What is the way what's what's the way. To optimize, a. Short. Vertical, a credit, spread of any kind whether it's a call vertical or a short work or a put vertical. Well. The best, the, the the highest profit outcome, without. Like tinkering, with the individual, legs is to. Allow that thing to go to expiration. Expire, worthless, if. It does get to expiration and it's out of the money and it expires worthless there aren't even any associated, transaction, fees at that point the. You're, just relieved of your obligation, you do, surrender, the value of your long option which was a little bit less than. The then the credit received on the short option but, net that's when your when, your optimal, scenario is realized, now. As you do that, remember. That, short. Contract, still, has. The. Chance that it could be it, could be assigned, at, any time right. That, risk remains with you throughout the trade. Another. Consideration is, you might you might close a position as it gets close to expiration, if. Let's say the. Trade is going well, the. Contracts, are still solidly, out of the money, but. The value, of the contracts, has just shriveled up to where you can get out for. Pennies on the dollar, well. Some. Traders might say you know what that's good enough I got, a dollar 20 upfront if I can buy out for 10 cents if I can buy out for you, know whatever some, nominal amount, maybe, they do that to be done with the trade and on to the next one another. Consideration is, to, close when, you get a specific percentage. Of the maximum gain so what I just threw out there was the hypothetical, where we. Got a dollar 20 credit, up front and as we were looking at it before at dollar 34, right but. In any case let's. Say that you have your own personal, guideline. That, you get out if you can exit, the trade for let's say I don't know 10%, of the, original, credit so. If we got a dollar 20 credit maybe if we could buy out for 12 cents that. Allows us to retain a dollar and eight cents. So. That's an example there, you. Might, consider. Buying, back the short strike. For five cents or less now. Imagine. This. We. We got into a contract, where, we sold the 185, bought. The 180 so, here's our strike, ok, current. Price is above that where's the current price on the stock it was about 188, right so the price is here and. Let's just imagine the price is going up as we're getting closer to expiration, what's. Happening to the value of those contracts, they're just shriveling, up and, it. Make then there may come a day and ultimately there will come a day if the option is still out of the money and you're, pressing up on expiration. I don't know exactly when that might happen but. As you get closer to expiration that value. Of that short contract, may shrink below, 5, cents, what's, magical about 5 cents well the nice thing about 5 cents is that. If you close out your short contract, for 5 cents, or, less there's.
Not A transaction, fee associated with that no commission. Well, why isn't it addressing, a long option, well. The, long option. At. That point may be worth nothing it might not be worth closing, out and. Even. Though it's worth nothing, let's say that you've gotten, to this point and there's still 3 or 4 days to expiration you're, able to pull off that short, contract, very inexpensively. The. Long option just, because it's not worth much right now as, long as there's time to expiration there's still a possibility right. Maybe. The stock plunges. After, your exit, and that. Long put, benefits. From that drop in price not. Likely to happen but it could, and. That might be a motivation, for some. Investors to hold on to that essentially. Worthless. Position. Okay. One final potential exit is if. Is this is a bullish trade right we got into it because we saw like a bullish bounce at a support level what. If the support level broke what. If you have now become technically convinced, that this that, you. No longer have the same outlook that could motivate a, trader to take the position off and under, those circumstances it. Could certainly will certainly, be at a, loss. Not being a maximum loss at that point but at some kind of loss, all. Right well class a. Few. Final things to remember for short portal short, put verticals we've already talked about Mosley's out-of-the-money. Short put verticals carry. More risk than potential gain yep, we discussed that taking. Max loss on one short put vertical could exceed the gains on multiple, profit of profitable, trades that's. What happens when you have a one. To three reward. To risk scenario. Assignment. Risks exists. From the moment the trade is opened yep. Regardless, of price max. Loss is possible, regardless. Of the probability, at the beginning of the trade but, we're, aware of these I've just like, to throw three miners and transaction. Fees may significantly reduce, profits, and increase. Losses. Especially. If. We're talking about those, low. Return. Option. Scenarios, where you've gone way out of the money like we discussed early in the session all. Right already time for me to set you loose I'm, gonna give you my survey, as we always do if you could fill that out that would be fantastic but, we've. Used our time today I hope, that you've enjoyed that discussion. We've. Accomplished, everything that we set out to do and so through.
The Accomplishment, of this agenda I just want you to walk away feeling much more comfortable with, the trading of short puts in your paper money account if you can do that you've got my purpose. Everybody. Coming. Up next barb Armstrong's gonna be filling in for James Boyd and she's gonna be discussing. Directional. Options strategies, you know she prepares. Well for her discussions, so that, should be a great discussion. Remember. The risks associated through your investing, we did use real examples, in today's discussion it's, not a recommendation or endorsement, of the securities or strategies, discussed and the, usage of a stop order is not a guarantee they'll buy or sell at a specific price all. Right so next time, we're. Gonna be talking about long, call, verticals, another bullish, vertical, spread strategy, but with its own set of considerations. And, a risk so, I'm looking forward to that discussion. Between. Now and then if you need some practice jump, into your paper money place a trade on a short put vertical and go, through these each, of these scenarios I think it could be very helpful, everybody, thanks for joining me today I'm looking forward to joining you again next week. Have. A great week until then in between now and then I want to wish you the very best of luck happy. Investing bye bye. You.
2019-05-06 15:06
