Increasing Your edge withVertical SpreadsJared A LevySenior Derivatives Specialist, Zacks.comJaredlevy.com
Jaredlevy.com 18 years experience Member of 3 major exchanges Traded tens of thousands of option contracts daily Senior equities strategist for Zacks.com◦ Whisper Trader, TAZR Formerly with PEAK6 & ONN.tv Managing Partner of Belpointe Alternatives Featured on CNBC (Fast Money), Fox, Fox Business, BloombergTV, CNN Radio Author of “Your Options Handbook” & “The Bloomberg VisualGuide to Options”
Successful tactics Forming your trade checklist Idea generation basics Grading your trades Vertical spread basics (example) Live selection process
Homework Experience (pitfalls and advantages) Statistics Technicals Strategy Selection Psychological control Money Management Exit Strategies (profit and loss) USE A DAMN CHECKLIST!!
• Find Targets• Confirm Fundamentals• Filter Technicals• Check News• Check Earnings• Check Volatility• Check ATR, Beta, etc• Run Theoretical Risk Scenarios• Set Targets, Stops, Set GTC wish orders• Execute
• Economic Environment• Where are We in the Economic Cycle?• Earnings Trends /Corporate Fundamentals• Technical patterns• News /Blog Flow• What are the Talking Heads Saying?• What are your peers saying?
• Details can be forgotten in heat of the moment• Ensures consistency• Helps with allocation, strategy selection• Rationalizes every trade• Weeds out the crap!
• A Rated Trade - Risk up to 10% or more of your total portfolioOkay to use riskier strategies (risk reversal, synthetic, double verticalspread, etc.)• B Rated Trade - Risk between 5-9% of account, but use more cautionOkay to use basic verticals and limited risk, higher probability trades• C Rated Trade - Risk between 2-5% of account, use high caution andonly low risk, high probability trades (out of the money verticals)Exit quicker than usual• D Rated Trade - Risk less than 2% of your total portfolio.This trade is more high risk or what we call a flier. Trades with lowerprobability can generate a profit, but probability will generally be lessbecause there are more than a couple issues.• F Rated Trade - Don’t do it if at all possible.
• Use a strategy guide!• Strategy selection• Substituting options for stock• Findings in macro & stock analysis• Another layer of analysis• Greeks• Alternative Vertical Spread• Volatility and Standard Deviation
• Trend following• Trade the signals• Exits• Don’t excessively pyramid!• Losing• De-correlate• Journal• **Get to know common trading mistakes
Vertical Spread TradingOne major tool in your arsenal
“Vertical Spread”A “Debit” Spread That Favors Time DecayAn Alternative to the Bull Put Credit
• Purchase Call Greater Delta (lower strike)• Sell Call Lower Delta (higher strike)• Both in-the-money• Same Expiration Month• Mildly Bullish Sentiment• Max profit, Stock Above Short Strike At Expiration• Debit Trade (can’t lose more than you pay)• Stock can stay flat & spread can potentially attainmaximum profit• Same risk as Bull Put SpreadFront Month ITM Bull Call SpreadDefined
Delta: .70 - .99Expiration: DTE 1-30Premium: Spread .20 or lessOpen Interest: Above 100Position: Below short call, distancedetermines risk and altersGreeksFront Month Bull Call Spread*Following these parameters will not guaranteeprofitable results. You must make your owninvestment decisions.
Delta: .10 - .80Expiration: DTE 1-30Premium: Spread .20 or lessOpen Interest: Above 100Position: At or below stock price,above long callFront Month Bull Call Spread*Following these parameters will not guaranteeprofitable results. You must make your owninvestment decisions.
• All Options Decay over Time.• Decay accelerates drastically in the lastmonth.• Short ATM call premium is greater and isdecaying faster than the ITM call.• Stock needs to stay at or above short strikeby expiration
I I I I I I I I+4+3+2+1$-1-2-3-4Buy Jan 15 Call for $6.10, Sell 20 Call for 2.80 (BCS $3.30) - Stock @ $21.00Breakeven $18.30………………………..IIIIIIIII16 17 18 19 20 21 22 23 24STOCK PRICEPROFIT&LOSS*$1.70 Max ProfitEntered Spread here$3.30 Max Loss
• Stock to expire at or above the short call• Take advantage of inflated ATM OptionTime Value• iVol to drop• Look for a target of 8-15% profit in trade inless than 15 days• Buy a Spread that has a minimum profitpotential of 10%• Good for directional earnings plays
More aggressive?◦ Widen distance between strikes◦ Place short strike closer or even at spot price◦ Delta, Gamma, Vega increased Less aggressive?◦ Narrow strikes◦ Create more distance between short strike and spot price◦ Delta, Gamma, Vega decreased
• Is Assignment a Risk here?• Can I lose more than what I pay?• Do I have to have money to buy the stock?• Will I have a margin Call?NO!*Contact your broker about expiration procedu
• You can lose your entire investment• Trade may have an upside-downrisk/reward ratio• Limited upside• Subject to volatility• You want volatility to fall as a general ruleRisks
• Cost of trade must not be MORE than max profit.• The closer the Short Call strike is to the stock, themore volatile the spread’s P&L will be. (Gamma)• Check your broker’s exercise costs; may be morecost-effective to exit trade on Expiration Day.• (Long Call will have to be exercised)
• Chart Starts to Weaken Substantially• Stopped out / Acceptable Loss• -Determine before entry• Profit Target Met• Expiration Friday• -On expiration, if the stock is above the call that you soldyou will attain max profit
More Advanced Concepts◦ Standard Deviation as a form of a stocks typicalmovement◦ Target “normal” range of stock◦ Sell call outside that rangeLEARN ADVANCED TECHNIQUES IN MY VIDEO SERIES!