Vertical Bull Call Spreads Revisited
For those readers looking to improve their trading results and create the unfair advantage they deserve, I have posted training video on How to Execute a Vertical Bull Call Spread.
This is a pair of positions in the options market that will be profitable when the underlying security goes up, sideways, or down small in price over a defined period of time.
It is the perfect position to have onboard during markets that have declining or low volatility, much like we have experienced over the past year.
I have strapped on quite a few of these babies across many asset classes over the years and they are a major reason why I am up 54.28% on a trailing 12-month basis, with the Dow Average gaining a lowly 6.3%.
To understand this trade, I’ll outline the math on a Home Depot (HD) vertical bull call spread which I executed on August 7.
Followers of my Trade Alert service received text messages and emails to add the following position:
Trade Alert - (HD) - BUY
BUY the Home Depot (HD) September, 2018 $180-$185 in-the-money vertical BULL CALL spread at $4.10 or best
To accomplish this, they can execute the following trades:
Buy 24 September 2018 (HD) $180 calls at…….………$17.60
Sell short 24 September 2018 (HD) $185 calls at……….$13.50
Net Cost:………………………….…………..…….….....$4.10
Potential Profit: $5.00 - $4.10 = $0.90
(24 X 100 X $0.90) = $2,150 or 21.95% in 32 trading days.
This gets traders into the position at $4.10, which cost them $9,840 ($4.10 per option X 100 shares per option X 24 contracts).
The vertical part of the description of this trade refers to the fact that both options have the same underlying security (HD), the same expiration date (September 21, 2018) and only different strike prices ($180 and $185).
The great thing about these positions is that your risk is defined. You can’t lose any more than the $9,840 you put up.
If Home Depot goes bankrupt, we get a flash crash, or suffer another Brexit type event, you will never get a margin call from your broker in the middle of the night asking for more money. This is why hedge funds like them so much.
As long as Home Depot traded at or above $184.10 (The lower $180 strike price plus your $4.10 cost) on the September 21 expiration date, you will make a profit on this trade.
At the time I sent out this trade alert, Home Depot traded at $196.15. So, the stock could have fallen by $12.05, or a hefty 6.14% over the next 32 trading days, and you would still make a profit on the trade.
The shares only need to close at $185 on expiration day for you to capture the maximum potential profit, which can be calculated as:
$5.00 expiration value - $4.10 cost = $0.90 profit
($0.90 profit X 100 contracts per option X 24 contracts) = $2,160, or a gain of 21.95%.
That is not a bad profit in this ultra-low return world in only 32 days.
As it turned out my timing was perfect and Home Depot Shares have since risen to $202.06 a share. The current market value of the Home Depot (HD) September, 2018 $180-$185 in-the-money vertical BULL CALL spread is now $4.90.
This means you can take 88.88% of the maximum potential profit now without having to wait the extra 18 trading days until the September 21 option expiration.
Now you know why I like Vertical Bull Call Spread so much. So, do my followers.
Occasionally, these things don’t work. As hard as it may be to believe, I am not infallible.
So, if I’m wrong and I tell you to buy a vertical bull call spread, and the shares fall not a little, but a lot, you will lose money.
On those rare cases when that happens, I’ll shoot out a Trade Alert to you with stop-loss instructions before the damage gets out of control.
To watch the video edition of How to Execute a Vertical Bull Call Spread, complete with more detailed instructions on how to execute the position with your online platform, please click here.
