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54 May / June 2003 basics T he fact is however, once you break through the idea of rigid terms and start looking at the concept itself youll see it is far from rocket science.

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54 May / June 2003 basics T he fact is however, once you break through the idea of rigid terms and start looking at the concept itself youll see it is far from rocket science. The long list of strategies available in options trading can be boiled down to one word. Its not complexity, its flexibility. Options allow you to take a wide range of risk and return profiles - much more than any stock or futures position will let you. With stocks you can go long or sell short. With futures you can spread trade different contracts. This is nothing compared to what you can do with options. Before we get tucked in to the subject of this article, well first assume that you know the basic four options positions: long call, short call, long put, short put. From here well look at the next level of strategy: bull call spreads and bear put spreads. The Bull Call Spread If you are bullish, but know that simply buying a call option or even buying the underlying would expose you to a little more risk than you feel comfortable, then a bull call spread may be a strategy worth considering. A bull call spread involves buying a call, say just out-of-the-money, then selling a call further out- of-the-money in the same expiry month. To understand why you would do this, lets dissect the trade. The purchase of a call option is a bullish strategy. Therefore, you want the market to go higher. When we then sell a call option further out-of-the-money it does two things: - Firstly, it partly pays for the cost of the purchase. It will not completely cover the cost of the long call since further out-of- the-money options will always sell for less. However, if the position moves against us (i.e. the market falls), the sale of the call option helps to reduce the total loss. - Secondly, the sale of the call option caps the upside. If, as expected the market rallies, the bought call option will be in profit. The sold option however will ...

Source: www.option1.com.au

 

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