Options Trading Lessons: Vertical Spreads

There are two main types of vertical spreads. There is the vertical call spread and the vertical put spread. Each spread allows you to do two things. First, you can buy it, making you long the vertical spread. Second, you can sell it making you short the vertical spread. Both can be employed to take advantage of directional stock plays. When we use the term 'directional stock play, ' we refer to using vertical spreads to capitalize on anticipated stock movements either up or down. A bull spread is used when the investor feels that a stock is most likely to go up. As we recall, 'bullish' means to have a positive outlook on a stock's future movement. There are two ways to set up a bull spread.

A Business Blueprint to Stocks

Because of the large size of the stock market, beginner investors seem to feel overwhelmed as to where to even begin investing their money. To most people, the stock market presents a tangled web of options but does not provide the road map of clarity to direct their way along way in their investment adventure. The key to investing in the stock market is to become as educated as possible so that you know exactly what is taking place at all times. This helps people to make logical and sound decisions about their money, thus, reducing the stress involved with investing. The average person, when beginning to entertain the idea of investing in the stock market, falls into one of two categories.

Options Trading Lesson: Spread Trading

In options trading, there are some basic lessons that are the backbone of many other successful options trading strategies. How to engage in spread trading in options trading to enhance potential gains is one of these lessons. Spread trading is a foundational tool that you should have in your options trading toolkit. It will allow you freedom and flexibility for enhanced profit and will give you defense against potential loss while reducing your overall risk. Now, let us look at this fundamental of options trading, the spread trade. We have demonstrated how well options function in unison with a stock position. They enhance potential gains, provide profit protection and limit the risk of the entire investment.

 

They Call it Mellow Yellow: Atomic Starts Drilling for Uranium in the Colorado Plateau

These days, investors are just mad about saffronâ " to take a page from Donovanâ s hit song. What with U3O8 trading at around $90/lb, yellow is definitely the color of money. Atomic Mineralsâ (TSX.V: ATL) management has taken it upon itself to test this novel colour theory by kicking off the drill program at its Summit Point and Box Canyon uranium projects along the Dolores Anticline in Colorado. The first hole, SP9, completed upon reaching the Chinle formation at 2100 ft. Hole SP1, on the opposite flank of the Anticline, the Chinle formation at 1560 ft. Currently, the drill contractor has been working its way back across the Anticline, with completion of the 1st phase of drilling program slated for December 21, 2007.

Options Seller Risk Reward

The seller of a time spread buys the nearer month option and sells the outer-month option in a one to one ratio. In order to profit from the sale of the time spread, the seller is looking basically for two things. First is a decrease in implied volatility. As volatility decreases, the out-month option (which the seller is short) loses money faster than the near month option (which the seller is long) because of the higher vega in the out month option. This will cause the spread to contract or lose value. That will be profitable for the time spread seller. Second, the stock can move. As stated before, a time spread is at its widest, most expensive point when it is at-the-money.

Options Buyer Risk Reward

Like most trades, time spreads have a maximum loss for the buyer. As a buyer, you can only lose what you have spent. If you paid $1.00 for the spread then your maximum potential loss is that $1.00. If you bought the spread for $2.00, then $2.00 is the maximum potential loss. The buyer of a time spread will be purchasing the out-month option while selling the nearer month option of the same strike in a one-to-one ratio. Since the out-month option will have more time until expiration than the nearer month option, the out-month option will cost more. This means the buyer will be putting out money (debit spread) which makes sense. The buyer can only lose the amount of money they spent to purchase the spread.

How to Calculate the Volatility of the Spread in Options Trading

To be able to calculate the volatility of the spread, we must equalize the volatilities of the individual options. First, let's move the June calls by moving June's implied volatility down from 40 to 36, a decrease of four volatility ticks. Four volatility ticks multiplied by a vega of. 05 per tick gives us a value of $.20. Next we subtract $.20 from the June 70 option's present value of $2.00 and we get a value of $1.80 at 36 volatility. Now the two options are valued at an equal volatility basis. Looking at this first adjustment where we moved the June 70's volatility down to 36 from 40, we have a value of $1.80 at 36 volatility. The August 40 call has a value of $3.

 

The Effects of Volatility on the Time Spread When Trading Options

When purchasing a time spread, the investor should pay attention not only to the movement of the stock price but especially to the movement of volatility. Volatility plays a very large roll in the price of a time spread and, as we have stated, the time spread is an excellent way to take advantage of anticipated volatility movements in a hedged fashion. Since the time spread is composed of two options, the investor should understand the role of volatility in options as well as in time spreads. Let's start with option volatility. An option's volatility component is measured by a term called vega. Vega, one of the components of the pricing model, measures how much an option's price will change with a one point (or tick) change in implied volatility.

Properly Calculating Accurate Volatility Levels

Understanding and properly calculating accurate volatility levels is imperative for spread traders. In order to get accurate volatility levels, you must first determine a base volatility for the two options involved in the spread. Getting a base volatility must be done because different volatilities in different months can not, and do not, get weighted evenly mathematically. Since they are weighted differently, you can not simply take the average of the two months and call that the volatility of the spread; it is more complicated than that. The problem is related to calculating the spread's volatility with two options in different months. Those different months are usually trading at different implied volatility assumptions.

Darling Announces Changes to Help Savers

A recent new ruling announced by Alistair Darling, the Chancellor of the Exchequer, means savers with money in banks and building societies will have the first  35, 000 of their deposits guaranteed, it has been revealed. Previously, savers would have had the first  2, 000 of their deposits absolutely protected, but only 90 per cent of the next  33, 000. The move can be seen as an attempt by Mr Darling, who announced the change alongside Alan Greenspan, former chairman of the US Federal Reserve, to avoid another Northern Rock-type crisis. He had hinted at the move just last week when he admitted he was considering adopting a US-style system which would move deposits held in a collapsed bank into a specially designed holding body before being paid back to savers.