So here is a simple spread. They can be short or long, puts or calls.
Most people with a little knowledge of trading understand a spread as the pricing of a financial product ie the bid to ask ‘spread’. The above 6750 put at 28, is a mid price and may itself have a spread of 27-29, and in the options world we like tight spreads. We may use a ‘limit order’*. Which means 18.5 is my limit I will not pay more. So just to make life interesting, the above put spread will have a spread (price quote) of say, 18-20.(Subtract 28 from 46.5). We take a view here that 18.5 would be OK based on Friday’s prices.
Get Your Head Around The Spread
The trade makes maximum profit of 100 if FTSE trades below 6750 at expiry, as we OWN the 6850 put, but sold the 6750put. FTSE can go to zero-we still have that 100 point spread. It is important to understand that with a long spread we OWN a portion of the move, like a share but without the randomness and worry that the CEO might be caught inflagranti delicto ( Google it!)
FTSE may never drop
-so we lose our 18.5 (£185 -remember it’s £10 a point or expressed another way 18.5 pence x 1,000). Thus we stand to make £1,000 and have staked £185 and have another 3 weeks to be right or wrong. Is this a good trade?** Honestly I do not know-the environment is flat, yet volatility is not cheap. Looking back at FTSE and VFTSE I cannot see any recent price action that made for great trades. That means nothing-we could be about to see huge volatility, and the US election could be a market mover-Hillary is a dead cert we’re told. Were the pollsters ever right?
*There are many order types. Those are for another time
** We can adjust or close out any time,remember
Just to be clear-the above trade assumes we BUY one 6850put and SELL one 6750 put for November expiry. We do not have to stick to one lot-we could BUY five, SELL three or Seven or Ten,or Twenty.This is just a simple one for one debit spread(debit means you pay for it,you OWN it) By starting with a defined risk trade with the potential to make five times as much,we can do a number of twists and turns,including if it looks like losing money. Remember our aim is NOT to lose money.
Just for fun imagine we bought 100 of these spreads -spend £18,500 to make £100,000.
Why would you do that? Well, if you had placed that sort of trade in mid august 2015 or early June 2016……
This trade hit 26 on Monday 31st – a profit of 40%. Cannot seem to pick a loser…….famous last words!
Please would you explain why the trade went into profit? The FTSE 100 did not go below 6946 yesterday, and VFTSE only went up to 17.0. Surely the put you bought was still out of the money? What am I missing?
the puts are indeed out of the money-that does not change the fact that the prices changed the trade at close today is 31-tomorrow it may well be 35 or so.the 6850 put is now 86 and the 6750 put is 55,price difference between the two is 31.
I am not being a genius here seriously!
Richard, welcome by the way- and you are right to question everything. I hope it is clear, I have posted the closing prices from the 2 puts at the bottom of the article.
I love options because there are so many different ways to trade- and we put these trades up for fun-and we can follow the progress-but honestly 40% profit is good,100% may be on the cards tomorrow. Please feel free to comment, we aim never ever to offend or try to humble anyone. We’ve made dumb mistakes and part of our process is sharing with others,but I will not share my real trades in case anyone gets misled. All the trades here are for fun,using real prices, no smoke or mirrors.
Thanks TT. I am fascinated by options – the most sophisticated form of trading I have come across, and with the big advantage that risk can be controlled (in theory). The problem is, from a UK perspective it is so difficult to get enough information to take it any further. Are there any brokers who even want to take retail traders’ money? And where do you find current prices for UK options? It is so different in the US – but then they do not have spread betting, I suppose. I am very pleased that you have started this blog. Textbooks are all very well for theory, but what really matters, and what I am hoping you will cover, is how you adjust positions when the market goes against you.