Buying and selling of the same type of option can result in establishing a spread. Trading a spread with the hope that the market declines means you have created a bear or bearish spread.
Bear spreads will profit if the market in the underlying stock declines. Investors can trade call spreads or put spreads. A call bearish strategy means you want both calls to expire, so you can keep your premium credit that was earned. Trading puts will be profitable in a down market, thus having the puts traded or exercised will result in a profit.
Call Bear Spread Example
Buy 1 WDF Sep 40 Call@4
Short 1 WDF Sep 30 Call@7
The above example will show a bearish strategy. The investor is buying a call option with a September expiration, a stike price of 40 (the right to buy the stock at) and he is paying a $400 premium. This buy call is a bullish option by itself. The Short position is in a call option with a strike price of 30 (the obligation to sell at price), and the investor is receiving a $700 premium.
This investor thinks the market will go down. He is collecting a $300 credit on the spread (the difference in the premiums paid and recieved), and he hopes the option expire. Having the market go down in a bearish direction will help this along. He is most certainly NOT bullish. If the market goes up and both options are exercised, he will be covering the short option at a price of $30 with a long option at a price of $40. He will lose money on the 10 point strike price spread.
The maximum gain in this trading spread strategy is $300. If both options expire, the maximum gain is achieved. This is a call bear spread.
Put Bear Spread Example
Puts can be bought and sold to create a spread. These spreads can be bullish or bearish. A bear position would be as follows:
Buy 1 DFT Oct 80 Put@6
Short 1 DFT Oct 70 Put@2
In this case, the investor is long the bearish option (a buy put is a bear option position), has the right to sell the stock at 80 and is paying a $600 premium. The option he is shorting has a 70 strike price (short put holders must buy the stock at the strike price) and is getting a $200 premium.
This is resulting in a net debit of $400. Since the investor has a loss of $400 and is controlling puts, the only way he will make money is if the options can be traded or exerised at a profit before the options expire.
The maximum gain would be if the market declined (bear) and both options were exercised. This would allow the customer to profit 10 points on the options. The difference between 80 and 70. The investor loses the premium debit of $400, so the new gain potential is $600 ($1000 - $400).
This is a bear put spread.
This type of trading is profitable in a declining market when using call options and collecting a premium credit or using puts when the investor has lost money initially on the premiums spend and received when the trading strategy was initiated.
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