The Nuts and Bolts of Alternative Option Trading

 

Bear Put Spread with a Naked Leg

Buy a Close-to-the-money Put

Sell an Out-of-the-money Put

Sell an Out-of-the-money Call

 

When to use a Bear Put Spread with a Naked Short Call Option? 

  1. You think the market will go down but buying put options outright are expensive
  2. The goal is to purchase a close to the money put for very little cost

Bear Put Spread with a Naked Short Call Option Profit Profile 

  1. Profit is limited to the difference between the strike prices of the long put and the short put plus the net credit or minus the net debit
  2. At expiration the breakeven is equal to the long put strike price plus the net amount paid for the spread
  3. BE = Long Strike Price - Net Premium Paid (if a debit)
  4. RBE = Short Put Strike Price + Net Premium Collected (if a credit)

What is at Stake? 

  1. Risk on the upside (short call) is theoretically unlimited
  2. The market trading above the short call is equal to being short the futures from the call strike price
  3. At expiration if the market is between the long put and short call you lose the net paid for the spread if executed at a debit.  If executed as a credit, the trader keeps the premium collected

You have likely heard about the complications associated with trying to pick market tops, the bear put spread with a naked leg is one way of attempting to do so while giving the market some breathing room.  This trade is capable of benefiting from a price reversal, but if the strike price of the naked short call is placed appropriately the risk to the trader at expiration may be considerably above the current futures market price. 

I believe that this trade is best used during times of extreme price moves and high volatility.  Executing it under other circumstances may increase the odds of a compromising scenario regarding the short call option. 

Looking at the next figure, you will see how a typical bear put spread with a naked leg may be constructed.  As the Euro rallied to an new all time high in mid-July 2008 a trader may have been able to sell the 163 call while simultaneously purchasing the 157 put and selling the 154.50 put for a net credit of 15 ticks or $187.50 before considering commissions and fees. 

Because this trade was executed at a credit, it is capable of making money at expiration at any point below the reverse breakeven point of 163.15.  This was figured by adding the net credit to the strike price of the short call option.  Below 163.15 but above the strike price of 160 the trade is profitable in the amount of the difference between the RBE and the strike price minus the futures price.  For example, if at expiration the futures price is 163.05, the trader would still be profitable in the mount of 10 ticks or $125.  To simplify, the only way that this trade can be a loser at expiration is if the futures prices is above 163.15; however, the risk is unlimited above the RBE of 163.15. 

The maximum profit on the trade is limited to the difference between the strike price of the long put and the short put, in this case 157 - 154.5 and is equivalent to $3,125 ($12.50 x 250).  The maximum profit is achieved if the futures price is trading below the strike price of the short put at expiration, in this case it is 154.50.

Figure 9

Euro Currency Chart

Share

DeCarley Trading on Twitter

Carley Garner Trading Books

  • All
  • A Trader's First Book On Commodities
  • Carley Garner
  • Carley Garner Books
  • Commodity Trading Book
  • Futures Trading Book
  • Learn To Trade
  • Learn To Trade Commodities
  • Learn To Trade Futures
  • Higher Probability Commodity Trading, new Carley Garner book

    Higher Probability Commodity Trading, new Carley Garner book

    According to Phil Flynn, Fox Business News contributor, this is Carley Garner's "masterpiece"! Order from Amazon today! "A great read for both beginner and advanced commodity traders. Carley nails the seemingly impossible task of leveling the playing field by imparting vital concepts in easy to digest bites ...she doesn't leave out the harsh realities and heartbreak many overzealous speculators face." -- JON NAJARIAN, co-founder NajarianFamilyOffice.com "I love the book... it's an MBA in trading for the
    Read More
  • Third Edition of A Trader's First Book on Commodities, now available

    Third Edition of A Trader's First Book on Commodities, now available

    In the latest edition of Carley Garner's beginners' book on commodities, she details everything you need to know about futures and options trading before placing a trade.  BUY NOW In their quest for trading commodities profitably, beginning traders spend a substantial amount of time studying market theory, various types of market analysis, and paper-trading in the futures and options markets.  Yet, almost all of them fail to take the necessary steps to ensure their trading
    Read More
    • A Trader's First Book On Commodities
    • Carley Garner
    • Carley Garner Books
    • Commodity Trading Book
    • Futures Trading Book
    • Learn To Trade
    • Learn To Trade Commodities
    • Learn To Trade Futures
  • Commodity Options the Book

    Commodity Options the Book

    It isn't free, but it's close! If this book saves you 2 ticks, you've recouped your investment.   Commodities are hot, as Jim Rogers would say.  Stagnant stocks and the massive bull rally in raw commodities have lured much of the attention away from Wall Street and toward down-town Chicago.  It is difficult to turn on the television or open the newspaper without being reminded of the impact that commodity prices have on our daily lives.   Traders
    Read More
  • Currency Trading in the FOREX and Futures Markets

    Currency Trading in the FOREX and Futures Markets

    Get a copy of Carley Garner's latest book at Amazon.com, or any major outlet! "Once again, Carley Garner demonstrates her ability to boil down complex concepts for individual traders. Trading Currencies in the FOREX and Futures Market will put budding currency traders ahead of the curve with its unique blend of the basics and some refreshingly unexpected material." ~ Karris Golden, Traders Press® "Carley is a smart trader and broker; she understands the markets and the importance of
    Read More

Newsletter Trial