Spread Trading using Options - A simple guide for traders and investors

EXCHANGE TRADED OPTIONSPart 2: Puts, Calls and Spread Trading

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Puts and Calls1

There are two different types of options available:

1 2Put Options Call Options



Put Options2

Put options gain value as the share priceof the underlying asset falls...



Put Options3

it will give the buyer the right but not the obligation to sell a parcel of shares for a greater value than it is worth on the market.



Put Options4

The more the share price falls the morethe put option will gain.



Call Options5

Call options gain value as the share priceof the underlying asset rises.



Call Options6

Call options give the buyer the right but not the obligation to buy a parcel of shares for a lessor value than it is worth on the market.



Call Options7

The more the share price rises the morethe call option will gain.



Puts and Calls increase in value when...8

Call Option

Underlying

value of share price increases.



Puts and Calls increase in value when...9

Call Option

Underlying

value of share price increases.

Put Option

Underlying

value of share price decreases.



Options Expiry10

All options have an expiry date and a trader or investor has the ability to choose an expiry month.



Options Expiry11

The more time until expiry, the more time value that the investor will need to pay.



Options Expiry12

An option buyer has two choices:



Options Expiry13

Either - Sell the option contract before the expiry to realise a profit or loss. (Trading the option)



Options Expiry14

Or - Choose to exercise their right to buyor sell stock at any time up until theexpiry day of the option.

This is often used by investors as a strategy to buy or sell shares.



Spread Trading15

Spread trading uses a combination of different options contracts to allow a trader to tailor their trade to a specific view of a stock, or market direction.



Spread Trading

The clear benefits of spread trading overjust trading single options is the ability toprofit from different market conditionsnot just direction.

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Spread Strategies

An options trader has the ability to profit from a rising, a falling and a neutral or sidewaysmarket.

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With spreads you can use:18

Directional strategies for a falling market.

Time decay strategies in a sideways or channeling market.

Directional strategies for a rising market.



With spreads you can use:19

There are spread strategies that can even profit if the market either rises or falls, as long as it moves in either direction.



Spread Strategies

This is a great alternative if you don’t have adirectional view but your view is that themarket will move.

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Credit and Debit Strategies21

There are two main types of spread strategies, which can be set up in many different ways to create different strategies in the market.




The two main spread strategies are:




1 Credit Spreads





1 2Credit Spreads Debit Spreads




Credit Spreads

In a credit spread, we receive money from the market to open a trade.

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Credit Spreads

The best-case scenario is for the options to be out-of-the-money on expiry day so that theyexpire worthless and you keep the creditreceived.

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Credit Spreads

An example of strategies which you will receive a credit upon entry are the:

1. Bull Put Spread2. Bear Call Spread

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Example Bull Put Spread28

This is a chart of CBA, where the overall trend is up.

We expect the share price to move sideways to slightly bullish.

Trend LineSupportResistance




To set up bull put spread, we simultanesouly buy one put option and sell another put option at a higher strike price.




Sell Put 80.00

Buy Put 79.00

To set up bull put spread, we simultaneously buy one put option and sell another put option at a higher strike price.




Sell Put 80.00

Buy Put 79.00

We receive a credit on entry on this strategy.

The ideal outcome will be the share price remaining above the higher strike, meaning the options expire worthless and we keep the credit received.




Max Profit 100%Breakeven 79.79

Credit to enter: 0.21cRisk of the trade: 0.79c Maximum Profit: 26.5%

Sell Put 80.00

Buy Put 79.00



Example Credit Spread

Investors commonly use credit spreads asthey can use the collateral value of theirportfolio to cover the risk.

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Debit Spreads

A debit spread is where we pay to enter the trade, and the money paid to enter is the maximum at risk.

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Debit Spreads

A debit spread has a bought and a sold option. The bought leg is more expensive, which results in paying money to open the trade.

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Debit Spreads

The sold option will offset the cost and the effects of time decay of the bought.

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Best Case Scenario

The best case scenario is for the options to be in-the-money on expiry day.

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Best Case Scenario

That means we close the trade and receive back from the market more than we paid.

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Debit Spread Strategies

Examples of strategies that we pay to get into:

1. Bull Call Spread2. Bear Put Spread

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Example Bull Call Spread40

This is a chart of SUN, where the overall trend is up.

We expect the share price to rise moderately.




To set up a Bull Call Spread, we sell one call option and buy another call option at a lower strike price.




Sell Call 14.00

Buy Call 13.50




Profit 100%

Breakeven 13.78

Loss 100%

Entry Price: 0.28c DebitPotential Profit: 0.22c or 78%




We pay to enter this strategy.

To realise a profit from this strategy, the share price needs to be above your break even point on expiry day.

A large movement higher before expiry will also result in a profit.

Breakeven 13.78



Why traders use debit spreads

Time decay is offset by the sold leg

They reduce the capital needed to trade

There is more flexibility to switch or repair a trade.

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Conclusion

By setting up strategies with more than one strike price, we can help reduce risk and trade a variety of market conditions.

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Conclusion

It is vital that before entering the market, you learn the skills and gain the experience to trade confidently.

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32Warnings and important information.Any advice contained in this communication is general only and does not consider your objectives, financial situation or needs, and you should consider whether it’s appropriate for you. If you are thinking about acquiring a financial product, you should consider our Financial Services Guide (FSG) at www.traderscircle.com.au and the relevant Product Disclosure Statement (if there is one available) first.

Trading options is not suitable for everyone. There is a risk that you can lose more than the value of a trade or its underlying assets. You should only act on our recommendations if you are confident that you fully understand what you are doing.

Past returns do not reflect future returns, and it is also possible to make significant losses. We employ expert traders and use strategies that maximise returns and minimise risk. However, there is always a risk of loss when trading and investing. This is general information, and is not prepared for your specific investment objectives, financial situation or needs. Consult a licensed investment adviser before making investment decisions. TradersCircle Pty Ltd, ABN 65 120 660 497 is a corporate authorised representative of OzFinancial Pty Ltd, AFSL number 241041.

Spread Trading using Options - A simple guide for traders and investors

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