Hey! It’s Sasha Evdakov founder of Rise2Learn and in this video I want to share with you how to trade options more specifically, the vertical spread.
The vertical spreads are fantastic option spreads to trade when you’re looking to trade out larger dollar stocks because it allows you to use less capital for trading those bigger stock.
First I want to show you the diagram behind what it looks like in a simplified version and I want to show you on the charts exactly what you’re looking for. So before we get into them vertical spread I want to talk about the regular call spread first of this is called a profit picture if you’ve never seen one before and a regular call spread you have one call that you’re purchasing and you’re looking for a directional bet to the upside.
Here you can see that we have a max loss of about 250 dollars and that’s the amount that you pay for your regular call. Now if you buy one you know deep in the money it’s going to be more expensive if you buy one further out it’s going to be less expensive, if you’re looking to buy more time premium it’s going to be more expensive and so on and so forth going with basic option concepts.
Now the thing that’s attractive for the regular call spread is that the maximum profit is unlimited and that’s why most people get it. Now, unfortunately the downside behind this is that you have theta decay or option premium decay. It’s kind of like buying a coupon, it’s worth a lot more at the beginning when you have four to six months to use it.
If you’re trying sell it to a buddy or a friend now that only has one or two days remaining it’s not worth as much because there’s probably not a lot of people that want it they you know they might not be able to use it and so on and so forth but most people they only know one way to trade and it’s a very simple directional way and in this case it’s just simple, it’s you buy a call spread so you’re looking for the upside.
Now when we’re going into a bull call vertical spread things are slightly different what’s different here as you can see if you have a cap or a maximum profit that’s’ limited, it’s kind of like a ceiling you can’t go past it. What you’re doing here is rather than just buying a call spread for direction reasons which would be this area here would go for the upside you’re also selling something a little bit further out.
In this case, something right around the $65 area because you don’t expect things to go infinitely up. Now think great advantages behind the bull call vertical spread is that you’re able to still capture the direction of movement of the stock, you’re not also limited to volatility risk in options or very minimal it’s very limited.
You don’t also have the theta decay or premium so much. Now you do if you’re more towards the maximum loss area but once you’re in the safe zone in the maximum profit area let’s just say somewhere around sixty dollars and over, you can just stay there until the option deteriorate and collect premium.
Looking at a real trade example I’m going to show you Amazon how to set up a bull call vertical spread. The first thing that we’re going to do is we’re going to set up a regular call spread and to do that we’re going to click this one right here and let’s just say we’ll do the 355 we buy a single and then we’ll analyze the duplicate trade.
Now when we analyze the duplicate trade this is what we get we get a single option contract at 355 dollars and we pay 1594, now since options come in lots of hundreds or 100 shares this is going to cost us if you look down here 1,590 dollars if the stock goes against us. Now this white line right here is the current price of what’s happening in the market so this is your current value of the option the red line here is the option value at exploration.
Overtime this option contract actually starts to deteriorate if I move the date forward you can see that it’s slowly deteriorating gets closer and closer. We’ll go to today and you can see that this happens right here now to offset this risk which is the theta risk, that’s the amount your option will deteriorate every single day we’re going to add another option contract and we’re going to sell one at a further price.
Let’s say we don’t believe Amazon will get to let’s say 370 level or something like that we’ll do a sell a single and then we’ll analyze the duplicate trade so now this gives us a new profit picture like this and you can see that I have a single here that I’m buying at 355 as the strike price and then I’m selling a single at 370 which is a dollar and seventy cents. So cost it’s selling at $870 and this one I’m buying at $1590.
Now my max a loss is $720 at exploration and my max profit is capped at $780. Now the stock can go up to a certain break-even point which is this little area right here which is the difference and I’ll break even at 362 dollars and 18 cents about right there. So after sthe stock passes this point and let’s just say it’s moving over to 364 dollars a share and once the stock gets here and if it stands still I will make money every single day because what happens to the option over time.
As you can see that I’m moving the date you can see that the white line slowly gets closer to that redline and reality is the white line but exploration is the red line so you can see that there’s huge advantages to getting in this region or area for your stock.
Going back to today you can play around with this profit picture and these different strike prices if you want so for example let’s just say I moved the strike price the one I sell at 365 dollars and maybe move the other one to three hundred fifty dollars and now you can see the stock doesn’t have to move too much you know for me to make a profit of course it’s better if it goes to the upside then I’ll make a profit but if the stock goes to infinity my max profit would still be the difference between those two.
At this point since I changed the prices it would be six hundred and ninety dollars and my max loss at 810 dollars so that’s basically a bull call vertical spread and that’s how you set one up. If you want to do one quicker you can just right click and buy a vertical and go there and change your strike prices on what you want to do and then do the same thing at right click and analyze duplicate trade.
Now you can see it already does all the calculations for you and then when we analyzed this it’ll give you one nice solid picture, with one nice entry right here so that way you can just manipulate the strike prices and you don’t have to make individual orders.
Of course you can do it very deep in the money and then you’re already in that area of profit where the stock doesn’t have to move but it’s better if it does and you have a little bit of cushion or you can do it further out to something like 375 and 370 where now the stock actually has to move quite a bit for you to make money.
Here you have option deterioration so it just depends how much you want to risk because here if you do it very far out you can see that there’s a hundred and sixty eight dollars at risk but your profit potential is 332 dollars if it gets to round 376.
Personally for me, I usually like to do one a little bit closer and I’ll start with maybe three or four or five contracts but you can go more if you want and that way as the stock price is increasing you can take one of two to start. If you just do one contract you’re not going to be able to take one of into profits or strength.
That’s just a little thought for you on how you can structure your option contracts.
Thanks for watching and remember to do what you love, contribute to others and most importantly live life abundantly.