Call Back Spread

Call back spreads are great strategies when you are expecting big moves in already volatile stocks. The trade itself involves selling a call (or calls) at a lower strike and buying a greater number of calls at a higher strike price. Ideally, this trade is initiated for a minimal debit or possibly a small credit. This way, if the stock heads south, you won't suffer much either way. On the other hand, if the stock takes off, the profit potential will be unlimited because you have more long than short calls. To maximize the potential for this position, many traders use in-the-money options because they have a higher likelihood of finishing in-the-money.

Example

Using International Paper (IP), a company that historically has been quite volatile, we can create a ratio back spread using in-the-money options.

In this case, you might buy two of the JUL 45 calls at $1.05 and sell one 40 call at $4.00.

IP trading @ $43.46
Buy	2 IP JUL 45 Call @ $1.05	$210
Sell	1 IP JUL 40 Call @ $4.00	($400)
Credit from Trade		($190)

In this case, you would receive $190 ((4.00 - 2.10) x 100 shares) for putting on the trade. If the stock dropped below $40, you would keep the $190. However, the real money would be made if the stock made a huge move to the upside. The upside breakeven for this trade would be $48.10. At this price, the 40 calls would be worth $8.10 (8.10 x 1) each while the 45 calls would be worth $6.20 (3.10x2). Factoring in the initial $190 credit, the ROI at this price would be 0. Above $48.10, the profit potential is unlimited.

Calculating the Breakeven

The easiest way to calculate the upside breakeven is by using the following formula:

Upside Breakeven = Long strike price + [(Long strike - short strike) x # of short contracts] - net credit/100*

*(or + net debit)

Using the data for this example, the breakeven calculation looks like this:

45 + [(45 - 40) x 1] - 190/100

The maximum loss for this trade would occur with the stock at 45 because the long calls would be worthless and the short call would be worth $5. Factoring in the initial credit of $190, the maximum loss on this trade would be $310 (1 contact x $5 x 100 shares - $190 credit).

Important

Before using Universal Broker's spread and combination one-step trading screens, options spread traders MUST understand the additional risks associated with this type of trading

Bull Put Spread

When your feeling on a stock is generally positive, bull spreads are nice low risk, low reward strategies. One way to create a bull spread that you might not immediately consider is by using put options at or near the current market price of the stock.

Example

If you have a bullish short-term feeling about Coca Cola Co. (KO) when it is trading at $54.14, you might put on a bull put spread by selling the 55 put for $2.55 and buying the 50 put for $0.85. In this case, the maximum profit would be the $1,700 you received when you initiated the position.

The maximum loss would be the difference between strike prices less the $1,700 credit you received for putting on the trade. In this example, the maximum loss would be $3,300 (((55 - 50) x 1,000) - $1,700). For margin purposes, however, the maximum loss is considered to be the difference between strike prices-in this case $5,000-because that is the amount that must be available should the position reach a maximum loss.

KO trading @ $54.14
Sell	10 KO AUG 55 Put @ $2.55	($2,550)
Buy	10 KO AUG 50 Put @ $0.85	$850
Credit from Trade		($1700)

If you like the idea behind the bull put spread, be sure to check out bull call spreads and bear put spreads. These can be comparable strategies depending on your objectives.

Important

Before using Universal Broker's spread and combination one-step trading screens, options spread traders MUST understand the additional risks associated with this type of trading.

Bull Call Spread

When your feeling on a stock is generally positive, bull spreads represent a nice low risk, low reward strategy. The easiest way to create a bull spread is using call options at or near the current market price of the stock. If the underlying stock is trading at $26, you could buy a 25 call and sell a 30 call.

Example

With DELL Trading at $26.85, you might buy one JUL 25 call and sell one JUL 30 call. By selling the 30 call, you lower your exposure, but you also lower your upside potential. You would have paid $2.95 for the 25 call and sold the 30 call for $0.50. In this case, your total cost-and the most you could lose-would be $245 ($2.95 x 100 - $0.50 x 100).

DELL trading @ $26.85
Buy	1 DELL JUL 25 Call @ $2.95	$295
Sell	1 DELL JUL 30 Call @ $0.50	($50)
Cost of Trade		$245

Your maximum profit is $255, the difference between the strike prices less the $245 you paid to put on the position. Even if the stock goes to 50, you still only stand to make $255 because while your 25 call is worth $25, the 30 call you sold is worth $20. To close the position, you would have to pay $20 for the 30 call when you sell the 25 call for $25. This limited upside is the price you pay for lowering your exposure (from $295 to $245) through the spread.

If you like the idea behind the bull call spread, be sure to check out bull put spreads and bear put spreads. These can be comparable strategies depending on your objectives.

Important

Before using Universal Broker's spread and combination one-step trading screens, options spread traders MUST understand the additional risks associated with this type of trading.

Protective Puts

With the market volatility we've seen over the past few years, more investors are recognizing the value of using puts as part of their everyday trading strategy.

For investors who put money in the volatile Internet or biotech sectors, the rewards can be enormous. But so can the risks--if the stock price rises instead of falls, this strategy may limit the upside potential by the cost of the put. By adding put options to their overall investment strategy, investors can better position themselves for any direction the market may head.

Using protective puts is simple and can be relatively inexpensive given the insurance value. For each 100 shares of stock you buy, buy one protective put at a strike price or two below the current market price. For example, if you buy a stock at $50, you'd buy either the 47.5 put or the 45 put. That way, if the stock plummets, you'll be able to sell the stock for close to what you paid for it.

On the other hand, if the stock jumps as you hope, you'll participate fully in the upswing less the small amount you paid for the protective puts. In this way, the puts act as an insurance policy.

Example

Let's look at AMGEN INC. (AMGN) trading at $50.66. It would take $5,066 to buy 100 shares. If you buy the shares, your downside risk, theoretically, is $5,066, with a potentially unlimited upside reward. Buying one protective put (to cover all 100 shares) limits the amount you can lose, should the stock fall.

To see how this works, consider the following:

AMGN trading @ $50.66
Buy	100 AMGEN INC @ $50.66	$5,066
Buy	AMGN OCT 45 Put @ $2.55	$255
Cost of Trade		$5,321

No matter how far the stock drops, as long as there is a protective put, the combined position will be worth $4,245.

Rolling Your Options

As the stock moves higher, you might want to roll the put up by selling the contracts you own and buying another one at a higher strike price. This way, you can lock in profit from the move higher. Too many investors have learned the hard way that what goes up rapidly can drop with equal momentum. So, if the stock jumps from $50 to $122, the 45 puts won't provide much downside protection. That's why it would be advisable to lock in profits by rolling the puts up to the 115 or 120 strike.