Short term stock options trading strategies that work reviews20 comments
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Both calls have the same underlying stock and the same expiration date. A bull call spread is established for a net debit or net cost and profits as the underlying stock rises in price. Profit is limited if the stock price rises above the strike price of the short call, and potential loss is limited if the stock price falls below the strike price of the long call lower strike. Potential profit is limited to the difference between the strike prices minus the net cost of the spread including commissions.
In the example above, the difference between the strike prices is 5. The maximum profit, therefore, is 3. This maximum profit is realized if the stock price is at or above the strike price of the short call at expiration.
Short calls are generally assigned at expiration when the stock price is above the strike price. However, there is a possibility of early assignment. The maximum risk is equal to the cost of the spread including commissions. A loss of this amount is realized if the position is held to expiration and both calls expire worthless.
Both calls will expire worthless if the stock price at expiration is below the strike price of the long call lower strike. A bull call spread performs best when the price of the underlying stock rises above the strike price of the short call at expiration. Bull call spreads have limited profit potential, but they cost less than buying only the lower strike call. In practice, however, choosing a bull call spread instead of buying only the lower strike call is a subjective decision.
Bull call spreads benefit from two factors, a rising stock price and time decay of the short option. A bull call spread is the strategy of choice when the forecast is for a gradual price rise to the strike price of the short call. A bull call spread rises in price as the stock price rises and declines as the stock price falls.
Also, because a bull call spread consists of one long call and one short call, the net delta changes very little as the stock price changes and time to expiration is unchanged. Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant. Since a bull call spread consists of one long call and one short call, the price of a bull call spread changes very little when volatility changes.
This is known as time erosion, or time decay. Since a bull call spread consists of one long call and one short call, the sensitivity to time erosion depends on the relationship of the stock price to the strike prices of the spread. This happens because the long call is closest to the money and decreases in value faster than the short call. This happens because the short call is now closer to the money and decreases in value faster than the long call.
If the stock price is half-way between the strike prices, then time erosion has little effect on the price of a bull call spread, because both the long call and the short call decay at approximately the same rate. Stock options in the United States can be exercised on any business day, and the holder of a short stock option position has no control over when they will be required to fulfill the obligation.
Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options. While the long call in a bull call spread has no risk of early assignment, the short call does have such risk. Early assignment of stock options is generally related to dividends, and short calls that are assigned early are generally assigned on the day before the ex-dividend date. In-the-money calls whose time value is less than the dividend have a high likelihood of being assigned.
Therefore, if the stock price is above the strike price of the short call in a bull call spread the higher strike price , an assessment must be made if early assignment is likely. If assignment is deemed likely and if a short stock position is not wanted, then appropriate action must be taken. Before assignment occurs, the risk of assignment can be eliminated in two ways. First, the entire spread can be closed by selling the long call to close and buying the short call to close.
Alternatively, the short call can be purchased to close and the long call can be kept open. If early assignment of a short call does occur, stock is sold. If no stock is owned to deliver, then a short stock position is created. If a short stock position is not wanted, it can be closed by either buying stock in the marketplace or by exercising the long call.
Note, however, that whichever method is chosen, the date of the stock purchase will be one day later than the date of the stock sale. This difference will result in additional fees, including interest charges and commissions. Assignment of a short call might also trigger a margin call if there is not sufficient account equity to support the short stock position. There are three possible outcomes at expiration. The stock price can be at or below the lower strike price, above the lower strike price but not above the higher strike price or above the higher strike price.
If the stock price is at or below the lower strike price, then both calls in a bull call spread expire worthless and no stock position is created. If the stock price is above the lower strike price but not above the higher strike price, then the long call is exercised and a long stock position is created.
If the stock price is above the higher strike price, then the long call is exercised and the short call is assigned. The result is that stock is purchased at the lower strike price and sold at the higher strike price and no stock position is created. A bull put spread consists of one short put with a higher strike price and one long put with a lower strike price. A bear call spread consists of one short call with a lower strike price and one long call with a higher strike price.
Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address.
Your email address Please enter a valid email address. Related Strategies Bull put spread A bull put spread consists of one short put with a higher strike price and one long put with a lower strike price.
Bear call spread A bear call spread consists of one short call with a lower strike price and one long call with a higher strike price. Please enter a valid ZIP code.