An Option Spread Can Relieve Some Doubt

I have this conversation with every options trading student I teach and in fact had it twice last week. I tell them that continually extracting money from the market is not easy. I always like to say there are three difficult phases when learning how to trade options. The first, and second most difficult in my opinion, is learning about options including the strategies and the greeks. The second is the easiest but by no means is it easy, and that is learning when and what strategies to use based on the charts, time and volatility. The last is no doubt in my opinion the hardest: managing the trade.

Option Spreads

If you only trade covered calls, cash-secured puts, long calls and long puts, you may be missing out on some of the best uses for options. If you are concerned about one or more of the option greeks affecting your position, consider a spread trade that can mitigate the influence of certain greeks. An option spread that involves buying and selling either all calls or puts will always have positive and negative greeks.

Option Spread Example

You have done your analysis and you are bullish on a stock moving higher. A long call would be an option so to speak, but what if you are worried about time decay eroding your option premium? A long call has negative theta so time passing will hurt the position based on time. You could sell a higher strike call option with the same expiration, which would add some positive theta to the mix. Short options (as in this case a short call) have positive theta. Time passing helps the position because it lowers the premium based on time. The option trader will have less exposure to time and possibly if the underlying moves closer to the short strike, positive theta because of the spread. Long options alone could never result in positive theta like a spread can.

Final Thoughts

A spread trade is not the answer for everything when it comes to option trading. As I continually remind option traders, everything is a trade-off when it comes to options. Knowing you can offset some potential positive or negative effects of the option greeks, like negative theta above, can give an option trader an edge. And that is what every trader should be looking for.

John Kmiecik, Market Taker Mentoring

Trader Education