Spread Index

Broken Wing Butterfly Spread

Wed, 20 Oct 2010 23:47:17 -0700

Description:
Like the butterfly spread, the broken wing butterfly is a directional play on an underlying. What sets the broken wing apart is that by varying the distances of the spreads, one can change the amount paid for the initial spread or the directionality. By increasing the long end of the butterfly strike prices, the spread carries more price movement but costs more to own. By changing the credit side of the spread, it is possible to lessen the price of the initial spread. This however, cuts down on the profitability and increases the risk.

Strategy:
The use of butterflies is very low cost way to purchase directional movements. The payout can be many times the initial value of the spread. As opex draws near and the short side of the spread nears the strike price, the spread will gain in value exponentially. Oftentimes, it is wise to take this spread off before expiration if it has reached near maximum potential. If for any reason the underlying overshoots or undershoots the strike price, the value can decline and the spread may go out worthless upon expiration.

Butterfly Spread

Wed, 20 Oct 2010 23:19:29 -0700

Description:
These spreads are very low cost high payout directional plays. As long as the spread is far enough from the expiration date, the spread will carry a low cost value. As expiration draws near however, the short options will begin to loose their time premium and the spread will begin to move more in tune with the stock’s price action as it nears the strike price of the short options in the spread.

Strategy:
Butterflies are a very low cost way to purchase directional movements. The payout can be many times the initial value of the spread. As opex draws near and the short side of the spread nears the strike price, the spread will gain in value exponentially. Oftentimes it is wise to take this spread off before expiration if it has reached near maximum potential. If for any reason the underlying overshoots or undershoots the strike price, the value can decline and the spread go out worthless.

Calendar Spread

Wed, 20 Oct 2010 23:01:12 -0700

Description:
This strategy is used to take potential advantage of volatility change for an option. The goal is to buy a lower volatility option than the option that is underwritten. Plotting the calendar is only theoretical since the price on expiration of the near month can only be speculated.

Strategy:
A trader can use this spread to try to lower the cost of ownership of an option they wish to own in the future. As long as the short strike goes out worthless then the far strike will not be called away for use in the future.

Condor Spread

Wed, 20 Oct 2010 22:11:04 -0700

Covered Spread

Wed, 20 Oct 2010 20:56:15 -0700

Description:
Covered calls are short options against an equity position for the purpose of taking in revenue on an existing position. Doing so caps upside gains on the equity to the short strike. If the price fails to reach the strike price the credit amount of the option is taken in. The inverse of this spread creates a synthetic call or put, but uses the stock as the instrument of gain and the call or put is simply a risk cap.

Strategy:
Most of the time this is method of option trading is used by investors wanting to create an extra revenue stream on existing investments. If an investor is willing to own the underlying however it might be advantageous trade the stock for a short put position and take in revenue on both sides of the strike price, keeping in mind that the short put still needs to be covered by cash or margin.

Iron Butterfly Spread

Wed, 20 Oct 2010 20:18:29 -0700

Description:
An iron butterfly spread is an aggressive non-directional play on a stock by selling 2 vertical spreads that are at the money(atm). By having a long and short position on the underlying this spread is counting on no movement for a profit. This strategy is depending on the stock to stay at a certain price and not a range. The upside profit of this spread is capped by the initial credit of the spread. As long as the underlying fails to move then the trader takes in the profit of the spread on expiration.
The iron butterfly is simply a short butterfly spread. By shorting the spread it changes from a low beta underlying play to a high beta play.

Iron Condor Spread

Wed, 20 Oct 2010 19:36:40 -0700

Description:
An iron condor spread is a non-aggressive, non-directional position on a stock selling 2 vertical spreads. By having a long and short position on the stock this spread is counting on no movement for a profit. The upside profit of this spread is capped by the initial credit of the spread. As long as the underlying fails to move then the trader takes in the profit of both spreads on expiration.
The iron condor is just a short strangle strangle spread. By shorting the spread it changes from a high beta to a low beta play.

Naked Call/Put

Wed, 20 Oct 2010 19:04:33 -0700

Description:
Puts and calls are the building blocks for options spreads. To buy a put (buy to open) is to buy the right to sell an underlying stock at a certain strike. This is useful to those wanting to short or protect gains in a stock and don’t want to carry the unlimited risk of shorting the equity but wanting to capitalize on a perceived move in an equity.
To buy to open a call is to purchase the right to buy an equity above a certain strike price. This allows the holder to be long the stock but not carry the entire risk of a downside move in the stock. This strategy limits the downside of the investment but allows the purchaser to participate in price movements above the strike price but not carry the risk of the rest of the downside in the equity. The risk of calls is the purchase price. Failure to reach above the strike price makes the options worthless on options expiration.

Strategies:
Purchasing naked puts and calls carry a large amount of risk in time decay. The deeper in the money(itm) the option the less the risk of time decay but the greater the value risk the option will have as well as more expensive. Buying deep in the money options can provide an investor with a way to leverage a directional play and by choosing longer dated options give the play time to work.

Ratio Backspread

Wed, 20 Oct 2010 17:28:43 -0700

Description
This spread is a volatility workhorse. If an equity is poised to move this spread is great for making a directional play and reducing some of the risk of the downside. The spread is created by selling an itm option and then purchasing 2 options atm or slightly otm. This way if the price moves in either direction it is possible for this spread to make money. The short side however will cap the gains in the wrong direction so the intent of this spread is to get the direction of the play correct for maximum profit.

Strategy:
The main goal of this spread is to catch a directional play to the unlimited gain side of the spread. However, the gains are not limited to the movement being in the correct direction. Depending on the amount paid for the long option end of this trade, the intent of the short option is to hopefully finance those trades if the play does not workout. This trade does carry risk if the underlying does not move, so be careful to watch it closely. This trade is great for catching a falling knife and limiting the risk to do so.

Stock Replacement

Wed, 20 Oct 2010 16:47:02 -0700

Description:
This spread carries a smaller capital value even 0, but not a smaller margin value as the underlying stock. Unless the purchaser is willing to own the underlying at any price this spread is very dangerous. It shrinks the cost of ownership but not the risk of ownership.

Straddle Spread

Wed, 20 Oct 2010 14:24:43 -0700

Description:
A straddle is a very aggressive non-directional play on a stock using a naked call and a naked put. By having a long and short position on the stock this spread is counting on movement for a profit, but a move in either direction. The upside profit of this spread is not capped by a short option like in a strangle. Not having the short on out of the money(otm) option incurs a time bleed as one waits for the price to make a move. These spreads tend to loose value very quickly if the stock doesn’t move very soon after purchase.

Strangle Spread

Tue, 19 Oct 2010 14:51:46 -0700

Description:
A strangle spread is a moderately aggressive non-directional play on a stock using 2 vertical spreads. By having a long and short position on the stock this spread is counting on movement for a profit. The upside profit of this spread is capped by a short option which contains the price and the net debit of the initial investment. However having the short on out of the money(otm) option helps prevent time bleed as one waits for the price to make a move. The spread consists of a long put vertical spread and a long call vertical spread.

Vertical Spread

Tue, 19 Oct 2010 10:22:56 -0700

Description:
Vertical spreads are the building blocks of almost every spread type. By themselves they can be used for moderately aggressive directional positions on a stocks price. The spread consists of a long put or call then selling a the further put or call at a strike price farther down from the long option strike price.