Bull Put Spreads … A unique way of doing options investing!

I wrote my first article about stock options that you can view here.

I may be jumping the gun on this one … but am so thrilled I wanted to get it out to you even though it may be a little in advance.

A month after my retirement I really needed something else to do as sitting around the house or simply riding the motorcycle or hitting the little white ball around the field was driving me insane.  So, I decided to start a new company for myself.  A company that would pay me a monthly income for sitting around the house.  Sound good?  Hang on!

I have been using Vectorvest.com for stock research for several years – and as a fully licensed advisor – I was not able to take advantage of all they had to offer.  At least not for my clients, and quite frankly with a couple hundred clients to take care of I simply did not have the time to take advantage of some of the offers I could have.

Several weeks ago they offered a 7 week investment course called “The Options Paycheck.”  The idea behind the course was to learn to use stock and index options in a way that would pay me money directly into my account regardless of which way the market was moving (up, down or sideways).  I know what your thinking … the same as me … “This sounds too good to be true!”  The cost of the course was $900 and to be frank, now that I am on a fixed income I questioned whether I should pay it or not.

The end result is that I decided to do two things:  One was to pay for the course and the other was to “pay it forward” on things I learned in the course.  That is the purpose of this article.  I am not going to go through the entire 7-week course in this article even though I have the notes (a full composition notebook of them) to do so.  In taking the course, unlike most students, I chose not to listen to the live webinars but rather to to listen to the recorded versions.  This would allow me to stop, back up and take notes at my own pace.  I seem to learn better that way – and Vectorvest made that available.  I don’t know exactly how many students they had at $900 per pop … but I do know there were students from all over the world in the class.

The technique used in the course was actually three techniques.  These were …

  • The Bull Put Spread
  • The Bear Call Spread
  • The Iron Condor

All of these spreads involved Credit to the account vs. debit from the account.  If you try to use them with your broker the actual legal name of the Bull Put and the Bear Call is called Vertical Put or Vertical Call.

Since my first spread trades were Bull Put Spreads … that is what I will talk about in this article.  To do a Bull Put Credit Spread first of all you have to have a market that is trending up.

Up trend

To do a Bear Call Spread you need to have a market that is trending down.

Down trend

Now I realize this could be confusing since in my first article I told you to Buy a Call, you wanted the market to be going up and to Buy a Put, you wanted the market to be going down.  However, keep in mind, that is “buying.”  In the case of using options to generate income we are not buying (putting out money) we are selling (taking in money).  Thus you want to do this in reverse.

Check out these two graphs of Boeing (BA):

BA 1

This is a one year graph of Boeing that shows a definite uptrend in the stock.  But not only do I want an uptrend in the one year time frame, I also want an uptrend in the one quarter (three month) time frame like below.

BA 2

Now if I were looking for appreciation, I may buy a call in hopes the stock would continue to trend up.  If I am looking for income and sell a call … I could get into trouble if I did not have the stock in the account to cover me and do what is called a “covered call.”  Selling a call option uncovered is called selling a “naked call.”

For example, I could sell the November 16 $400 call (the stock is not at $392.30) and the buyer of that call would be willing to pay me $10.05 per share (or on 100 shares $1,005).  Not a bad income for doing nothing.  But if that stock goes against me and shoots up to say $500 per share … the call buyer could exercise (his right) and force me to buy the stock at $500 and sell it to him (my obligation) for $400 costing me ($100 x 100 shares = $10,000). Pretty risky.  This is why when selling calls you need some insurance (such as the actual stock in the account – though we will talk about another kind of insurance later).

So, when the market (or stock in this case) is trending up don’t sell a naked call … sell a Put Option.  In this case I could sell the $380 Put Option and the buyer of that Put (who believes the stock is going to go down) would pay me $8.45 per share (or $845 for one contract since each contract is 100 shares).  Now think about it.  Some people who may want to buy BA do not want to pay the current price of $392.30 since they know the stock has a history of going up an down (look at the charts).  However, they may be willing to pay $375 to $380 per share.  They could put in a limit order to purchase 100 shares at $380 or $375 and wait to see if the stock goes down to that level and have the order hit … but why not go ahead and sell a Put at that amount … collect some premium … and if it does not hit that amount by expiration … do it again.  It’s like having a limit order (since you are obligated to buy at the strike price if hit) with an income for having the limit order.

All that being said … in The Options Paycheck … you never really want to own stock.  So you never want to have the option assigned or exercised.  You also want to be covered if you are.  Hence the “spread.”

What you would actually do is Sell a Put at one strike price and buy a Put at a lower strike price.  This way if the stock is trending down and you are forced to buy it at one price you will have the option to sell it at another slightly lower price – cutting your losses.  The Put Option you buy is your insurance policy against purchasing a stock that is in a downtrend.

Here is an actual trade that I did two days ago on October 1, 2018:

  • I sold 15 contracts of the the Nov 16 BA with a strike price of $365.  At the time BA was trading at about $375 per share.
  • The I bought 15 contracts of the Nov 16 BA with a strike price of $360.

I was paid $6.90 per share for selling the 15 contracts and I paid $5.60 per share for buying 15 contracts.

The net difference was $1.30 per share.  When we multiply this by 1,500 shares (that’s 15 contracts) the amount of money credited to my account was $1,950.00.  Now that is not bad.  However, that is the maximum profit I can earn on this trade or combination of trades.  But, that is not my profit target.  My profit target is $975 or 50% of the initial income.

Why only 50%?  You don’t want to get greedy.  You must look at the other side.  If the stock goes against me and I hold onto these options until they expire (which I won’t) I could end up with a total net loss of $5,550.  So the risk to reward ratio is 5550 divided by 1950 or 2.85:1 which really is not bad.  We can take trades up to 5:1 on stocks or up to 10:1 on indexes … but we must be ready to mitigate them (roll out and do new trades) if they turn against us to keep losses low.

In this case I told you my profit target was $975.  This means if the premiums of both trades hit $0.65 (and they will as the stock trends up) I will close out these trades for a cost of $975.  So, $1,950 minus $975 = $975 profit.  However,  if the stock drops to $365, the strike of my first option sold, and I exit at that point the most I can lose is $1,590 (not the $5,550 shown in the chart below) which gives me a risk to reward ratio of 1.63:1.

Here is what my trade looked like earlier today (and you may want to magnify this to read it though I will explain below).

BA Options

As you can see, if I sold today I’d be up $675 in net profit … not bad for two days.  I need that $675 gain to move to $975  in order to close this one with my 50% profit target.

I did another trade on October first as well.  In this one I did the following:

  • I sold 20 contracts of the the Nov 16 SPX (the SPX is the S&P 500 Index) with a strike price of $2820.  At the time SPX was trading at about $2,925.
  • The I bought 20 contracts of the Nov 16 SPX with a strike price of $2810.

I was paid $15.93 per share for selling the 20 contracts and I paid $14.88 per share for buying 20 contracts.

The net difference was $1.05 per share.  When we multiply this by 2,000 shares (that’s 20 contracts) the amount of money credited to my account was $2,100.  Now that too is not bad.  However, that is the maximum profit I can earn on this trade or combination of trades.  That is not my profit target.  My profit target, again, is $1,050 or 50% of the initial income.

Here is what that trade looked like earlier today:

SPX Options

As you can see this was up slightly (about $300) at the time of taking this snapshot.

So, if I closed out both of these trades today I would have made more money than the class cost me.  Remember, I paid $900 for the training.  In selling the class they suggested one may earn the cost of the class back in the first couple of trades.  If my BA trade pans out I will have earned it back on the first trade.

Now they tell us these trades normally last a week to 10 days from start to finish.  I just completed day two and it is looking interesting.  We will see what happens the rest of the week.

I will keep you posted and I plan to do another two again next Monday.

I’d love to be able generate about $2,000 per week net doing this.  That would equate to a retirement income of about $100,000 per year for not doing much.  Now I need to figure out how to make it a business so I can get some tax deductions.  There’s gotta be a way … but that is going to take some research.

In the meantime … have a great week and look for hidden opportunities in this Great American Stock Market!

Jerry Nix

 

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