Option Buying & Spreads
Most options expire out of the money and worthless; therefore most traders lose when buying options. Heritage West still believes there is opportunity in buying options; however, you must be very selective. We don’t believe in buying options just because a market is extremely high or low. One must consider the fundamental and technical conditions of the market, along with historic and statistical option volatility and all other significant trading factors. Remember, though, the key factor is still going to be picking the correct market direction. There are usually several different trading scenarios and strategies to take advantage of an emerging profit opportunity. We will help you implement the correct strategies to suit your objectives and risk parameters. There are strategies that combine both futures and options designed to mitigate risk while still providing significant profit potential.
Here are a few examples often used:
Bull call or bear put spreads involve the writing and buying of options at the same time. If corn were trading at 240, we could buy one corn 240 call and write one 280 call with the anticipation of corn trending higher. The 280 call sold would subsidize the 240 call, and likely produce a much better risk to reward ratio. The profit is limited to the difference between the 240 and 280 strike prices, less the net premium debit.
Ratio spreads involve buying calls or puts and writing multiple calls or puts that subsidize or even pay in full for the options purchased. If corn were trading at 240, we could buy one corn 240 call and write two 280 calls with the same expiration date. This would be in anticipation of corn trending higher, but not above 280 before option expiration. We’d be collecting the same amount of premium as the option purchased, so even if corn continued lower we’d lose nothing. Our highest profit would be attained at 280 based on option expiration. We would have 40 cents or $2,000 gross profit on the one 240 corn call we purchased and the two 280 calls sold would expire worthless. Above 240 we would give back our profit penny for penny up to 320, our break-even point based on option expiration. There is risk on the one uncovered 280 call above 320, based on expiration. Above that point we would lose penny for penny.