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Trading Bull Put Credit Spread is also known as Selling Vertical
Puts. I will use these terms interchangeably throughout this column.
As the name implied, this is a bullish strategy utilizing put
options with a credit posted to our broker account. We are option seller
in this strategy.
By the end of Wednesday
April 14, 2010, the option chain table for IBM stock for the
month of May 2010 should look like the following table:
|
|
May
|
2010
|
|
Option
|
Chain
|
for
|
IBM
|
stock
|
|
|
|
|
|
IBM
|
131.25
|
2.22
|
|
|
|
Puts
|
|
|
|
|
|
|
|
|
|
Strike
|
Symbol
|
Last
|
Change
|
Bid
|
Ask
|
Volume
|
Open Interest
|
|
|
125
|
IBM52210P125
|
1.25
|
-0.43
|
1.20
|
1.25
|
50
|
8131
|
|
|
130
|
IBM52210P130
|
2.82
|
-1.03
|
2.81
|
2.89
|
310
|
6045
|
|
Please notice the option symbols have been changed to a more
descriptive symbol with the stock root followed by the expiration date,
put or call option, and strike price.
IBM stock closed at $131.25, up $2.22 for the day. Let’s say we are
bullish about IBM stock and we want to use Bull Put Credit Spread strategy.
We sell IBM May 130 Put and buy May 125 Put for a $1.57/share credit.
Please notice I use the last settled price to come up with the
$1.57/share credit ($2.82 - $1.25 = $1.57).
We approach a conservative option selling here. Notice we sell OTM options.
As long as IBM stock traded above $130/share at the closing bell on Friday May 21, 2010,
we don’t have to buy the stock, our options expire worthless and we keep
$1.57/share for the profit. Since IBM is already traded above $130/share,
our chance for a profitable trade is higher than if we sell ATM or ITM
options. In this strategy, our maximum profit is the credit we collected.
Our maximum loss is the difference between strike prices minus the
credit. In this trade, our maximum loss is $5- $1.57 = $3.43.
We sell 130 put because we forecast IBM stock will stay above $130.
We buy 125 put to limit our loss to just $3.43/share just in case we are
wrong in our forecast. Think of selling vertical puts as selling naked
put with insurance.
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