Saturday, November 2, 2013
Bull Credit Spreads
You could utilize bull credit spreads if you have a neutral or bullish bias on
the underlying futures market. In this strategy you sell a close-to-the-money
put and buy a further out-of-the-money put. The idea is to collect premium
in a steady or rising market as time decay decreases the option’s value. The
purpose for doing a spread is to limit your risk in case an extremely unpre-
dictable adverse market move occurs. By selling the closer-to-the-money
put, you will be collecting more premium than you pay for the out-of-the-
money put you are buying.
Your risk is limited to the difference between the two strike prices minus
the premiums that you collected. The profit potential is also limited to the
net premium that you collect minus the commissions and related fees.
Again, it is important to know these fees so that you can work them into
your profit/loss calculations.
For those who believe in income-generating trades, a good example is
to use this strategy with stock index futures where options expire nearly
every month. Stock index futures attract these option strategists because it
is necessary to sell premium in an option market that has expensive values
to make the risk worth the reward. The higher the volatility, the higher the
premium is, especially for close-to-the-money puts. Stock index options
meet that criteria. In a slowly uptrending market, a trader can put on these
positions and collect premium, knowing what the risk and rewards are.
There is no need for precise timing to execute this trade strategy, only a
conviction that the futures market will remain at or above the same level by
the options expiration day. A margin requirement or good-faith deposit may
be required for this strategy.
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