One of the great things about options is their flexibility.
When buying shares, you can only make money if the market rises. But you can profitably trade options no matter what direction the market is moving.
Last week we saw how you can use a “bear call spread” if you are bearish about a stock or index.
It’s something we use to great success at my options advisory The S&P Trader.
Yet it’s not the only strategy we use. Today, I want to demonstrate a “bull put spread.” You use this strategy if you are bullish.
It’s a great way to profit if you think a stock or index will trade sideways or rally.
As I mentioned last week, don’t be put off by the strange name… It simply means that we are bullish and the strategy uses put options. And because it is a “spread,” we are buying and selling put options simultaneously.
So let’s check out an example to see how it works…
A Two-Part Trade
In the bottom half of the S&P 500 Index (SPX) chart below is our momentum indicator, the Relative Strength Index (RSI).
When the RSI tested and bounced off support (green line) in late April and early May (red circle), SPX also bounced…
S&P 500 Index (SPX)
Source: e-Signal
So if you believed that this level was going to continue to hold, you could write (sell) a put option at level ‘1’ (upper orange line) at 4030. (Please note this is an example and not a trade recommendation.)
By writing the put option, we collect premium – our income.
But with that comes an obligation… If SPX is trading below 4030 on the day of the option’s expiry, we would have to cover the difference between the index closing price and our 4030 strike price.
If the SPX fell heavily, that could mean steep losses – even after accounting for the premium we collected.
That’s where the second leg of the trade (lower orange line at ‘2’) fits into our strategy…
Take another look:
S&P 500 Index (SPX)
Source: e-Signal
This second leg is a put option we buy with the same expiration date. And it protects us if the market falls by putting a cap on any potential losses.
|
Free Trading Resources Have you checked out Larry’s free trading resources on his website? It contains a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out. |
How It Plays Out
In our example, we might receive $8 for writing the put option at 4030. Then we might pay $3 for buying a protective put option at 3980.
That would mean our profit is $5. (Remember, each options contract represents 100 shares, so this equates to $500 per contract.)
By buying the lower strike put option, we do give up some of our profits. But its “insurance” protects us from large losses should our trade analysis prove wrong.
And if we’re right and the market stays flat or rises, then we get to keep the rest of our collected premium ($500 per contract).
And that’s why this strategy is yet another useful way to generate income out of the market.
In The S&P Trader, we’ve used these kinds of strategies to earn more than $9,000 per contract traded (if you traded two contracts, for example, it would be $18,000) since the beginning of the year.
If you’d like to learn more about how it all works, I’d encourage you to check out a presentation I did recently. You can watch right here.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Mailbag
Today, two subscribers share their experiences with spread trading…
Dear Larry, Thank you for all of your great trade recommendations! My current gain for 2023 is $252,934… I have paid off most of my mortgage, gone on road trips with my girlfriend, and paid bills with my Opportunistic and S&P Trader returns. Now I have to save to pay no interest loans and my capital gain taxes due in October. Your trades are helping me tremendously! Thank you.
–Mark A.
Larry & Staff, Thank you for all the good advice, great trade setups, etc. You have totally turned my thinking around on making money in any market condition. Takes a lot of stress off, and at 75, that is no small thing.
–Steven T.
As always, send in any questions or comments to [email protected]. We love to hear from our readers.