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Today, we touch base with a bearish strategy utilizing call options
with a credit posted to our account when we enter the trade. This strategy is also known as selling
vertical calls.
By the end of Thursday, September 23, 2010, IBM stock closed at
$131.61/share, down $0.90/share from the previous trading day. Let say we
are bearish about the stock and we chose to sell vertical calls on this
stock. The option chart of IBM stock for the month of November 2010
should look like the following table:
|
November
|
2010
|
Option
|
Chain
|
for
|
IBM
|
stock
|
|
|
|
|
IBM
|
131.61
|
-0.90
|
|
|
Calls
|
|
|
|
|
|
|
|
Strike
|
Symbol
|
Last
|
Bid
|
Ask
|
Volume
|
Open Interest
|
|
125
|
IBM112010C125
|
8.25
|
8.20
|
8.55
|
93
|
548
|
|
130
|
IBM112010C130
|
4.90
|
4.90
|
5.00
|
424
|
792
|
|
135
|
IBM112010C135
|
2.36
|
2.36
|
2.42
|
498
|
1970
|
|
140
|
IBM112010C140
|
0.91
|
0.91
|
0.97
|
994
|
3514
|
For simplicity purpose, we will use last option prices to determine
net credit.
Let’s look at 3 scenarios here:
1. Sell 135/140 calls: We
sell 135 call and buy 140 call for a net credit
of $1.45/share.
2. Sell 130/135 calls: We
sell 130 call and buy 135 call for a net credit
of $2.54/share.
3. Sell 125/130 calls: We
sell 125 call and buy 130 call for a net credit
of $3.35/share.
To make money in this strategy, the stock has to close below the
lower strike price and both options expire worthless. Our max gain is net
credit and max loss is the difference between strike prices gap and net
credit.
In scenario 1, we sell OTM option. This is a conservative move. The
stock needs to close below 135 for us to be profitable. Notice IBM stock
already traded below 135 when we enter the trade.
In scenario 2, we sell ATM option. The stock has to move below 130
for us to be profitable.
In scenario 3, we sell ITM option. This is an aggressive move. The
stock has to close below 125 for us to be profitable.
Please notice we trade higher winning probability for a lesser
profit.
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