Bull Spreads with Options

I just placed my first options trade, so I'm eager to see how it works out.

I placed a BULL SPREAD on some May 2001 PPD Call Options.

For those that don't know, a BULL SPREAD is where you buy options AND sell options, where the options are on the same security, at the same date in the future, but the strike price for the one you buy is lower than the strike price for the one you sell.

To be specific, I traded call options for May 2001 in PPD at a strike price of 40 and 45.

That means that if at May 2001, the share price of PPD is below 40, both are worthless and I lose all the money I paid.

If however PPD is above 45, then what happens is:
- On the option I bought, I make $5 + the excess over $45
- On the option I sold, I lose the excess over $45

So that means my MAXIMUM PROFIT is $5 (well, really it's $5 x 100 x the number of option contracts I buy, as each contract represents 100 shares)

My question to the experienced option traders out there is -- If PPD share price goes up quickly so both options are in the money, should I trade out of the position early, or hold until expiry? Or what do you think should determine that?

Regards,

Thomas.

Thomas, all I can say is, for a first time options trader, you are one brave dude!!

I have never tried a bull spread. The only strategy I've tried is a straddle, which for those who might be interested in knowing is buying a call and a put on the same stock at the same strike price and for the same expiration dates.

However, in my case, with my first straddle, the darn stock traded sideways for quite a long time, so I ended up losing on the put and gaining very litttle on the call. The strategy was a good one, but I ran out of time and had to decide on getting out of the better of the two evils.

Now I just stick with straight calls. I might buy a put if there has been some bad news after hours, or at the start of the trading day. But nowadays, every experienced trader is also trying to short the same stock, thus driving the puts up, and making it harder for the little people like me to get in.

Good luck. Hope you get some feedback to your question.

Eliz.

> I just placed my first options trade, so I'm
> eager to see how it works out.

> I placed a BULL SPREAD on some May 2001 PPD
> Call Options.

> For those that don't know, a BULL SPREAD is
> where you buy options AND sell options,
> where the options are on the same security,
> at the same date in the future, but the
> strike price for the one you buy is lower
> than the strike price for the one you sell.

> To be specific, I traded call options for
> May 2001 in PPD at a strike price of 40 and
> 45.

> That means that if at May 2001, the share
> price of PPD is below 40, both are worthless
> and I lose all the money I paid.

> If however PPD is above 45, then what
> happens is:
> - On the option I bought, I make $5 + the
> excess over $45
> - On the option I sold, I lose the excess
> over $45

> So that means my MAXIMUM PROFIT is $5 (well,
> really it's $5 x 100 x the number of option
> contracts I buy, as each contract represents
> 100 shares)

> My question to the experienced option
> traders out there is -- If PPD share price
> goes up quickly so both options are in the
> money, should I trade out of the position
> early, or hold until expiry? Or what do you
> think should determine that?

> Regards,

> Thomas.

Elizabeth,

Thanks for your comments. :)

As I've probably mentioned before, I'm currently studying a Commerce/Economics degree (4 years + 1 for Finance honours) and I've just finished 3rd year. This semester I took a class called "Options, Futures and Other Financial Derivatives" so I thought I'd put some of what I learnt to practice and take a position.

The range of different strategies you can do with options is quite diverse -- bull spreads, bear spreads, calendar spreads, butterfly spreads, diagonal spreads, strips, straps, straddles, and strangles -- anyone who didn't know I was talking options might get the wrong idea about me. ;)

Anyhow, options are quite interesting. By combining options with other options or with shares, it's almost possible to create almost any payoff you like.

Perhaps next I'll try my hand with futures, heh.

- Thomas.

> Thomas, all I can say is, for a first time
> options trader, you are one brave dude!!

> I have never tried a bull spread. The only
> strategy I've tried is a straddle, which for
> those who might be interested in knowing is
> buying a call and a put on the same stock at
> the same strike price and for the same
> expiration dates.

> However, in my case, with my first straddle,
> the darn stock traded sideways for quite a
> long time, so I ended up losing on the put
> and gaining very litttle on the call. The
> strategy was a good one, but I ran out of
> time and had to decide on getting out of the
> better of the two evils.

> Now I just stick with straight calls. I
> might buy a put if there has been some bad
> news after hours, or at the start of the
> trading day. But nowadays, every experienced
> trader is also trying to short the same
> stock, thus driving the puts up, and making
> it harder for the little people like me to
> get in.

> Good luck. Hope you get some feedback to
> your question.

> Eliz.

Thomas,

When options are in the money they behave exactly like shares (futures).

You already made the maximum on the spread, why would you want to hold on till the expiration?

The market may reverse and end up between 40 and 45 (you make less) or even drop below 40 (you lose money).

So, get out.

Simon

They're not both in the money at the moment -- if the share price passes $45 then I'll be at maximum profit of $5 per share (minus a certain amount due to the bid/ask spread on reversing out of the position).

At the moment trading out would result in no profit.

I expect PPD to go up in price today, however, due to the sole analyst following the stock upgrading his earnings expectation for this quarter.

- Thomas.

> Thomas,

> When options are in the money they behave
> exactly like shares (futures).

> You already made the maximum on the spread,
> why would you want to hold on till the
> expiration?

> The market may reverse and end up between 40
> and 45 (you make less) or even drop below 40
> (you lose money).

> So, get out.

> Simon

If you can get half the maximum payout, take it. Set your profit target for this trade at $2.50 and if you see it, take it. J. Rackham

> They're not both in the money at the moment
> -- if the share price passes $45 then I'll
> be at maximum profit of $5 per share (minus
> a certain amount due to the bid/ask spread
> on reversing out of the position).

> At the moment trading out would result in no
> profit.

> I expect PPD to go up in price today,
> however, due to the sole analyst following
> the stock upgrading his earnings expectation
> for this quarter.

> - Thomas.