| The options market is definitely an exciting one. | | | | worth just $220. With 3 contracts, that would be |
| Not only can knowledgeable investors reduce the | | | | a loss of $6,000. Ouch. |
| risks associated with their current portfolios, but | | | | Buy Lower Priced Put Option |
| they can generate a decent amount of income | | | | One way to reduce that risk is to purchase a |
| through many other strategies, particularly when | | | | protective put at, say, $230 in this example. So, in |
| volatility is high and the investor implements an | | | | keeping with the illustration, if Apple were to drop |
| options strategy that will be financially beneficial. | | | | to $220, the trader's risk would end at $230. So |
| Of course, there are many different ways an | | | | while $1,050 was generated in income, the trader |
| options trader can generate safe income, but one | | | | would have to buy shares valued at $220 for |
| of the safest with limited risk potential is the | | | | $240, generating a loss of $6,000, or $4,950 |
| credit spread position. Ultimately, the risk is limited | | | | when you strip away the $1,050 earned originally. |
| while the income can be decent (but also limited). | | | | However, since the trader owns the $230 put, |
| The credit spread allows an options trader to | | | | those same shares worth $220 could be sold for |
| write (sell) a put option and simultaneously buy a | | | | $230, generating a gain of $3,000. This reduces |
| lower-priced put option. The difference in price will | | | | the total loss on the transaction to $1,950. |
| be the maximum potential return. Risk is limited | | | | How This Makes Sense |
| because if the share falls below the lower-priced | | | | This strategy makes sense if one can statistically |
| option, the option holder's position has been | | | | support that Apple will not drop below the higher |
| covered. Let's take a closer look at the two | | | | priced option. But, since markets behave |
| different options. | | | | erratically at times, buying the lower priced put |
| Sell Higher Priced Put Option | | | | option helps reduce the potential risks. Likewise, if |
| Let's look at Apple. At a price of, say, $260, a | | | | one were to own 300 shares of Apple at $260 |
| credit spread might involve selling the $240 put at | | | | and watch the value drop to $220, the loss would |
| $3.50. At 3 contracts, the income generated from | | | | actually be $12,000; using the credit spread |
| the sale, excluding commissions, would be $1,050 | | | | strategy outlined here would yield a loss of |
| with roughly 21 days to expiry. Not amount of | | | | $1,950, still substantial, but not as devastating as |
| income for 3 weeks. However, the risk is that | | | | holding the underlying shares. |
| shares could drop to $220, in which case the | | | | Investors who want to invest in options are well |
| options writer (the person selling this higher priced | | | | advised to take only calculated risks and should |
| option) would have to pay $240 for a stock | | | | seek professional advice whenever they trade. |