AI
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Wednesday, December 29, 2010 12:15:05 PM
Here is good explanation...
http://daytrading.about.com/od/optionsstrategies/a/BullPutSpread.htm
The only thing I would add is that I don't sell "in the money" puts...like the article suggests. I will have the SELL leg "out of the money", which decreases the risk even further. Read the article and tell me what other questions you have.
The goal is to sell an out of the money PUT, hoping the security moves sideways or a little up, and pocket that premium. Buying a deeper "out of the money" PUT, helps you with downside risk, as the article explains. It cuts your profit a little bit, but the risk can be substantially reduced as can the margin requirements to make the trade.
Ex...I could have sold 24 contracts of RIMM 55.00 P for $0.69 / per contract and pocketed $1656.00. However, my margin requirements would have been 20% of the underlying value of the security (ie $55.00 x 100 shares x 24 contracts x 20%) or $26,400. The reason is that my downside is huge... but if I turned it into a spread...in my case a $5 spread by buying the RIMM 50.00 P for 0.13, it decreases my credit proceeds to $1344 ($0.69-$0.13 x 100 shares / lot x 24 contracts), but limits my downside to the difference in the spread and limits my margin requirements to $10,000ish (24 contracts x difference in strikes x $100). That is why I turned my sold naked PUT into a spread.
Addendum:
I just put the straight naked PUT sale into my trading platform and the Maximum loss would be $5,435.00 per contract at current market value for that option ($0.65), whereas the maximum loss per contract for the spread is $444.00 per contract based on yesterdays prices. That is a 10 fold exposure to the risk of the investment. I think it makes more sense to limit your upside by about 20% by limited your downside by >1000%. That is the difference in the spread.
http://daytrading.about.com/od/optionsstrategies/a/BullPutSpread.htm
The only thing I would add is that I don't sell "in the money" puts...like the article suggests. I will have the SELL leg "out of the money", which decreases the risk even further. Read the article and tell me what other questions you have.
The goal is to sell an out of the money PUT, hoping the security moves sideways or a little up, and pocket that premium. Buying a deeper "out of the money" PUT, helps you with downside risk, as the article explains. It cuts your profit a little bit, but the risk can be substantially reduced as can the margin requirements to make the trade.
Ex...I could have sold 24 contracts of RIMM 55.00 P for $0.69 / per contract and pocketed $1656.00. However, my margin requirements would have been 20% of the underlying value of the security (ie $55.00 x 100 shares x 24 contracts x 20%) or $26,400. The reason is that my downside is huge... but if I turned it into a spread...in my case a $5 spread by buying the RIMM 50.00 P for 0.13, it decreases my credit proceeds to $1344 ($0.69-$0.13 x 100 shares / lot x 24 contracts), but limits my downside to the difference in the spread and limits my margin requirements to $10,000ish (24 contracts x difference in strikes x $100). That is why I turned my sold naked PUT into a spread.
Addendum:
I just put the straight naked PUT sale into my trading platform and the Maximum loss would be $5,435.00 per contract at current market value for that option ($0.65), whereas the maximum loss per contract for the spread is $444.00 per contract based on yesterdays prices. That is a 10 fold exposure to the risk of the investment. I think it makes more sense to limit your upside by about 20% by limited your downside by >1000%. That is the difference in the spread.
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