Credit Stock Options
Stock options are derivative securities that give the option holder the right to buy or sell the underlying stock at a set price for a fixed period of time. The nature of option contracts allows investors and traders a host of strategies for both conservative and aggressive traders, in both up and down markets. Option strategies that provide an immediate credit to your account are a way to lock in the profits of future price moves.
Other People Are Reading
-
Background
-
Call options allow the holder the right to exercise the option and purchase the underlying stock at the strike or exercise price. Put options provide the right to sell the underlying at the strike price. Sellers of option contracts receive the price or premium of the option and are obligated to either sell (call) or buy (put) the stock at the strike price if the option is exercised by the option holder.
Sellers or writers of option contracts are said to be "short." Purchasers are in a "long" position.
Pricing
-
Option prices or premiums are a function of the underlying stock price in relation to the strike price, the time until the option expires, and the expected volatility of the underlying stock. If the price of the underlying stock is above the call-option strike price, the option is "in-the-money," or ITM. The amount the option is ITM is the intrinsic value of the option. If the stock is below the strike price, the option is "out-of-the-money," or OTM. Time premium is the amount of an ITM option price that is not intrinsic value, and the price of an OTM option consists entirely of time premium. Call-option prices increase as the stock price moves toward or above the stock price and the further away the expiration date.
Put options are ITM when the stock price is below the strike price. Put options increase in value as the price of the underlying stock falls.
Option contracts are for 100 shares of the underlying stock and the cost is 100 times the quoted price.
-
Spreads
-
Option spread strategies involve buying (going long) options of one strike price or expiration date, and simultaneously selling (going short) an equal number of contracts at a different strike price or expiration date. If the short contracts are more expensive than the long contracts, the net result will be a credit to your brokerage account. The goal of a credit spread is to have both sides of the spread reach the expiration date OTM and expire worthless.
Bull Put Spread
-
If you believe the underlying stock will increase in value, a credit spread is written using put options. For example, Google stock (symbol: GOOG) is trading for $488 per share. The $490 strike price put option is $27.50 and the $470 strike put is $18.80. A credit spread is written, selling one $490 put for $2,750 and buying the $470 put for $1,880, providing a credit of $870 to your account. The maximum profit of $870 is earned if GOOG is above $490 at the expiration date. Maximum loss is if GOOG is below $470 at expiration and is the difference in the strike prices less the credit received. In this case, the maximum loss is $2,000 minus $870, or $1,130.
Bear Call Spread
-
To profit if the underlying stock falls in price, a credit spread is written using call options. Calls of a lower strike price are bought and an equal number of higher strike price contracts are sold. Again, the maximum profit is the amount received as a credit and happens if all contracts expire worthless. Maximum loss is the difference in strike prices less the credit received and occurs if all contracts expire ITM or above the higher strike price.
Considerations
-
Credit spreads are popular because when they work as planned, the positions close out automatically with no additional cost. If the underlying stock price does not move in the predicted direction, close out positions early to minimize the loss or even make a small profit. There is no good reason to hold a spread position until the maximum loss potential is reached.
Broker commissions and bid/ask spreads can have a significant effect on the profitability of any option strategy. Remember to include these costs when calculating the possible outcomes of any option strategy.
-
