- Bet that the stock will go up, or
- Bet that the stock will NOT go down
Using options to capitalize on a bullish move is not rocket science. We can purchase a call option, which provides unlimited upside, then sell it when the pattern ends (or at a certain pre-defined profit level).
A nice feature of purchasing a call option you can only lose the amount you paid for the option, but a drawback is that you pay the market a premium for time. So in the case that you purchase a call option, you really need a strong conviction that the stock will actually go up. If the stock stays flat, you end up losing because you paid time premium. With that in mind, maybe it would be better to make the bet that the stock will not go down. How can we do this?
If we sell a put option we can effectively be long the stock, but remember, a huge drawback of being a seller is that you have the potential to face an enormous liability. Being a seller is better, particularly in the sense that you are paid for time erosion. So is there something that can be done to enable us to collect time premium, be long the stock, limit my liability, and still be leveraged? Yes! We simply sell one put option at-the-money and then purchase one put option that is out-of-the-money from the same month, then collect the price difference between the contracts. This idea is fundamental and is commonly known as a bull-put spread. We will use the position above and below to capitalize on bullish signals.
A nice feature of purchasing a call option you can only lose the amount you paid for the option, but a drawback is that you pay the market a premium for time. So in the case that you purchase a call option, you really need a strong conviction that the stock will actually go up. If the stock stays flat, you end up losing because you paid time premium. With that in mind, maybe it would be better to make the bet that the stock will not go down. How can we do this?
If we sell a put option we can effectively be long the stock, but remember, a huge drawback of being a seller is that you have the potential to face an enormous liability. Being a seller is better, particularly in the sense that you are paid for time erosion. So is there something that can be done to enable us to collect time premium, be long the stock, limit my liability, and still be leveraged? Yes! We simply sell one put option at-the-money and then purchase one put option that is out-of-the-money from the same month, then collect the price difference between the contracts. This idea is fundamental and is commonly known as a bull-put spread. We will use the position above and below to capitalize on bullish signals.
