The Tycoon Report

Slightly Bullish? Double your money!

Options trading is really one part science, one part art. Yet to the dedicated artist who really understands the numerical side of things, this knowledge can yield great dividends.

The options trader has many tools at his disposal. Tools for bear markets or bull markets, rough waters or calm seas. Knowing what type of trade is appropriate in what situation can lead to unbelievable profits in any market conditions.

In this article, I'll discuss the bull call spread. What it is, how to predict your return, and where i myself have found them useful.

An option spread is created by buying one option, and selling another. Its similar to a covered call, but instead of the call being covered by stock, its covered by another option position.

The simplest of all spreads is the bull call spread. You buy a call at one strike price, and you sell a call at another strike price. An example at this point would probably be helpful.

Currently, apple is trading at 136.20.

buying the 135 option expiring this month would cost 4.70.

Selling the 140 option expiring this month would get you 2.45.

So if you buy the 135 strike for 4.70, and sell the 140 strike option for 2.45, whats the overall result?

Lets look at a couple possibilities come expiration time.

If the stock is trading below 135, you lose your investment. If it looks like this is a strong possibility, i would close the position immediately.

If the stock is trading at 136, then the position would be worth $1. the 135 strike which you own is worth $1, while the one you sold is now worthless. You still lost money though, because your net investment was 2.25 (4.70-2.45).

If the stock is trading at 137.25, the position is worth 2.25, and you broke even. Now here is where it gets exciting.

If the stock is trading at 135, the position is worth $5. You only invested 2.25, so your return on investment would be 122%. Considering this is a return in just 2 weeks, I think its one most people could definitely live with.

The thing that gets most people is what if its over 135? Then the option you sold doesn't expire worthless, so how does that factor in? The answer is deceptively simple. The position is still worth $5. If the stock is at 140, the call you bought is worth 10, while you owe 5 to the guy you sold the 135 option too. As long as its above 135, your position is worth 5$.

Your max profit in a bull call spread is always the difference in strike prices, minus the cost of t he spread. in this case, $5-$2.25=$2.75. You make 2.75 max on a 2.25 investment.

So now you know what the trade IS, when should you use it? From my experience, the best use of this tool is trading significant pivots. A pivot is when the stock changes directions. A "significant" pivot is when it changes directions at a critical point, such as when it bounces off a moving average, or when it bounces off a well established resistance level. I don't consider it a buy signal until it passes the highest point on the previous bar. (Using a OHLC bar chart) An example of this is AAPL. On September 7th, it hit the 30 day moving average. The next trading day, it went up in value by a couple dollars. This would be considered a "significant" pivot, and so this is when i'd set up a bull call spread on aapl. Taking into consideration its last high, i'd estimate it goes to around 142+, so i'd set up the 135:140 call spread. Its important to keep time span in mind. To figure out how long it will take for it to bounce to the expected price, look at how long its taken in the past. If there is a consistent bounce height or timeframe, then you can be reasonably sure history will repeat itself.

this is a high risk strategy, and i would recommend people papertrade it for a minimum of 3 months; preferably 6 months, before using real money in these trades. If there are any questions, just ask.