Bear Spread – Understanding Options for a Bull & Bear Market Part 6
Bear Spread – Understanding Options for a Bull & Bear Market (Part 6)
We’ve talked about selling shares short when you’re bearish, buying puts, buying a put spread selling a call spread, they’re all negative Delta bearish trades. The three-way would take two of those and combine them for a different risk profile here. Buying four of the $95 puts and then selling a call spread up top, doing that for a credit of 40 cents. Buying the outright puts costs us upfront and trading the three-way leaves a credit. So, it’s exactly the same analysis, I won’t walk through the details because it looks the same. If the stock moves in the direction we expected it to move, our p&l here will be buying puts profits nicely.
Our risk is contained at $1,720. If the stock drops, we start making money and we continue to make money on the downside. On the three-way, our risk is not nearly as contained as buying puts; but we’ve eliminated Theta and on the downside if we’re correct with our bearish outlook we make money at the same rate as the long put. Because we own the same put but the overall profit is enhanced, because we’ve added to it a short call spread up top.
The three ways going to keep outperforming and the slope of the graph is going to be the same between the three-way and buying the $95 puts. So, different ways to put things together and looking at it on the graph. You know, same as we saw before the breakeven point it is much, much different than $95 puts for $4.30. That puts us at $90.70, as a break-even point, and up here up above $105 selling that for 40 cent credit. So, 105.40. Just a huge difference in where the breakeven points line up with the stock. Somewhere in here that can be very enticing to want to capture the downside potential that you think is going to happen and not have to worry about Theta and knowing that your break-even point at expiration is way up here. Be concerned and then realize that you’re giving up a much more conservative, controlled risk profile to get those other benefits that I mentioned and that’s the three-way bearish side. So, we’ve covered a lot. Out right positions, and we added one piece to do the verticals and then added another piece to do the three ways. One ways, two ways and then three ways.
The single-leg trades, there certainly is a set time and a place to get that directional exposure with limited risk. Adding a vertical can control that risk, choosing your strike prices wisely with your short strikes being a level where you think the stock might get to but not breakthrough. That’s generally how you’re choosing your short strike prices and then we added an element and got to the three-way offering more potential profit.
Eliminating Theta decay having this sort of no money down concept, you know, you’re likely going to have to have a small debit or maybe achieve a small credit depending on your strike price selection. But having the long option with directional potential and not having Theta, that’s the main benefit for doing this three-way while accepting much greater loss. That’s walking through, I guess we could say, one ways, two ways and three ways as a way to sum up what I went through.
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