Ok here's the concept. It's similar to a covered call where you own stock and sell calls against the stock you own. In this case I own long 22 calls instead of stock. Like stock, you can sell (short) options as well as buy them. Time decay (theta) erodes premium. When you sell an option you put decay in your favor. Aslo, when earnings are due option premium is higher than normal. You can sell that premium at the higher cost and buy it back cheaper. The type of trade I did was called a diagonal spread.
I bought 20 Dec 22 calls at .43 which costs me $860.00
I sold 20 Nov 21 calls at .40 which puts a credit of $800 into my account. My stock breakeven point is determined by adding the credit recieved on the sell to the strike price. So my breakeven price on the sold calls would be $21.00 + $.40= $21.40 on expiration (today). There was basically .50 of extrinsic value on those calls because the stock was trading at 20.90 when I sold them.
If GPS closes below 21 today, I keep the $800.00 on the 21 calls I shorted. This essentiallly pays for the 22 Dec calls I bought.
Here's howto determine profit/loss potential
Buy the longer term 22 call .43
Sell the shorter term call .40
Net debit= .03 You determine te net debit by subtracting the premium paid for the purchased call from the premium recieved from the sold call. .40-.43=-.03
Max Profit is determined by subtracting the net debit from the differences in the strike prices. In this case it is 22.00-21.00-.03= .97.
Of course I can continue to sell next month calls against the 22.00 calls if I am inclined (creating what is known as a vertical creit spread), once I close this trade out.
Max loss is determined by the debit paid, in this case .03.
You should look at these type of spreads to increase your probability of winning trades. This is how the floor traders on the CBOE trade.
Key Concepts:
You create a diagonal spread by buying a long-term option while simultaneously selling a shorter term option with a different strike price
Diagonal bull spreads are spreads that allow you to profit on neutral or up trending stocks.
Diagonals have a maximum profit and loss potential.
You can trade the same diagonal multiple months in a row.
There is no margin requirement
Requires Level 3 trading authority.
AI
