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Bull Call | Bear Put

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Learn how to set up and profit from debit spread options

If you have a 10 strike wide 95-105 call debit spread and the stock price is 100 ( in the middle )

How do you set up a debit spread with respect to the debit payed and the break even price

You will ideally want to set up a debit spread so that the break even price is just around the stock price. The break even price is determined by the spread width and the debit premium.

If the break even is just around the stock price, then it is possible that you break even or profit even if the stock price does not move.

If you have a 10 strike wide 95-105 call debit spread and the stock price is 100 ( in the middle ) the profit on the option is potentially 5 dollars ( 100 minus 95 ). You will want to collect a premium of about 5 dollars.

What is the value of the short strike if the stock does not move it all?

If the stock price does not move at all, the short strike will expire worthless.

The long call, however, will be worth about 5 dollars ( 100 minus 95 ) which, if you bought the spread for a 5 dollar debit, you would break even on the trade.

Building Blocks are combinations of buying and selling of calls and puts

What is the value of the option if the stock price moves in your favor and above your short strike?

If the stock moves in your favor and moves above the short strike, you will achieve maximum profit. The maximum profit is calculated by the width of the strikes minus the debit you paid.

In this example, the width is 10 and the debit it 5. So if the price goes above the short strike, you will collect a 5 dollar ( 10-5=5 ) profit.

What is the value of the option if the stock prives moves against you and below your long strike.

If the stock moves against you and moves below the long strike, you will achieve maximum loss unless you adjust or manage your trade. Maximum loss is simply the price of your debit premium. In this case it is 5 dollars.

You will want to manage this trade by rolling the short strike down toward the long strike, while also narrowing the width of the spread.

Rolling the short strike should gain you a credit ( lets say .30 cents ) while also narrowing the width of the spread.

If the original debit was 5 dollars and you were able to get another 30 cents. Then even if you still lose in the trade, your loss has decreased from 5 dollars to 4.7 dollars.

If the stock price now manages to rally ( before expiration ) and rally back above the short strike, you will now be profitable albeit a lesser profit than originally designed. Remember that you managed this trade by bringing down the short strike and narrowing the strike width to 5 points wide. Your profit is based now on a strike width of 5 minus the debit which is now 4.7.

What is the value of the option if the stock does not move... and stays between your short and long strikes.

If the stock price does not move at all, the short strike will expire worthless.

The long call, however, will be worth about 5 dollars ( 100 minus 95 ) which, if you bought the spread for a 5 dollar debit, you would break even on the trade.

You might not want to manage this trade if you are at least breaking even, It might be hard to move the short strike down for a credit and it might be harder to move it down and still pay for the expense of commissions. This scenario will depend on whether or not you can move it down for a reasonable credit.

What is the only reasonable adjustment strategy for debit spreads that move against your trade?

Intro Paragraph

Checklist considerations

this management strategy at least will decrease the cost basis and maximum loss
If we roll the option for a debit, we will take on extra risk and possibly lock ourselves into a bigger loss

Buying a Call

Profit and Loss Chart

Maximum Profit Potential: Unlimited
Maximum Loss Potential: Premium Paid for the Call
Expiration Breakeven Price: Call Strike + Premium Paid for Call
Estimated Probability of Profit: Less Than 50%
Assignment Risk?

Option Basics

How Does a Call Option Change with Volatility and Time

A call option will benefit from :

A rise in stock prices
A rise in volatility
An early rise in stock price ( time kills the stock value )

Positive Delta – Call prices rise when the stock price increases, which benefits the call buyer. Conversely, call prices fall when the stock price decreases, which is not good for the call buyer.

Positive Gamma – A long call’s position delta gets closer to +100 as the stock price increases and closer to 0 as the stock price decreases.

Negative Theta – The extrinsic value of options decays as time passes, which is detrimental to a call buyer

Positive Vega – An increase in volatility will increase the value of a call option ( indicated by positive vega ). Conversely, a decrease in volatility will decrease the value of a call option ( indicated by a negative vega

Buying a Call

Management and Adjustments

Maximum Profit Potential: Unlimited
Maximum Loss Potential: Premium Paid for the Call
Expiration Breakeven Price: Call Strike + Premium Paid for Call
Estimated Probability of Profit: Less Than 50%
Assignment Risk?

Option Basics

Tips and Tricks

A call option will benefit from :

A rise in stock prices
A rise in volatility
An early rise in stock price ( time kills the stock value )

Buying ITM -in the money call options will

Increase the amount of directional exposure since in the money options have deltas closer to +1
ITM options are less affected by theta decay

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Options Learning Basics?

Learning Options

The basic foundation introduction

Getting Started

Keep in my my most important lessons even though you might not understand them yet. Read all the pages keeping these lessons in mind.

Most important lessons I have learned

Trading options or even stock market investment in general is a form of gambling. The house ( in this case the options market ) is rigged against you through the option premium prices. The market makers have already manipulated your odds of winning against the house by increasing or decreasing the price of the stock option. You can win this game, but you will have to thoroughly understand the rules of the market and how to play your hand in different situations. In blackjack terms, you will need to know when to ask for hit, pass, or fold if you have a two kings.
Understand that the extrinsic value of an underlying stock, which is determined by time and volatility, must work out of a stock before you actually make any form of profit. Therefore, if you have chosen the right direction and the underlying stock price has moved in your favor, you option will still be negative until all of the extrinsic value of the stock has worked out of the contract value. Read more
Know that you do not have to take a contract all the way to expiration. In fact, you should close out most contracts between after making about a 30 to 50% profit. Read more
Don’t even think about starting options without understanding management strategies for if your contract appears to be going against you. This strategy might be as simple, albeit gut-wrenching, to close the contract early for a loss. Remember that all contracts can be adjusted ( managed ) to save you from a maximum loss in your account. Read more
Credit spreads are the easiest option strategies to manage. Debit and naked options are the most difficult to manage. Narrow spreads are safer ( although less lucrative ) than wide spreads. Read more
Understanding how to read charts, in particular, understanding how to identify support and resistance levels, has been the most important step in creating a safe and successful trade. Read More

Strategy Building Blocks

Intro Paragraph

Building Blocks are combinations of buying and selling of calls and puts

Be able to draw out the profit and loss graph for each
Note that these building blocks can be combined

Situational Awareness

Situational Strategies

Earnings Season

20 days before earnings

The day before earnings

The day after earnings

Increasing volatility

Decreasing volatility

Reading Charts and Indicators

In order to make a successful trade, you need to identify the direction and strength that you think a stock will move. At the same time, you identify your safety nets ( resistance and support ).

What are you trying to learn from the indicators