1. WOW14 – Trading credit spreads (cash inflow I)
Host: Georgio Stoev, Product Manager
November 17, 2018

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3. Week 14 The Bear Call Spread
Review of the markets/watchlist
Introduction to Vertical Credit Spreads
The Bear Call Spread
How to set it up and manage
Review

4. Review of Markets S&P 500 tracking stock (SPY) down 8.5% vs. VIX 30%
Euro-Stoxx 50 (FEZ) is down 6.3%
China (FXI) down 10.5%
Bonds 3.4%
Oil down 22%
Volatility in the market is creeping back up to Aug/Sep levels
2016 could be a repeat of 2015 in volatile trading
What is investor to do? – most obvious one to adhere strictly to money management rules (proper position size, adjustment of trades, using ETFs rather than individual stocks to name a few)

5. What are Vertical Credit Spreads?
The term “spread” is a loosely used term that can describe any multi-leg option strategy (covered call, bull call and so on)
Literary it means the difference between the bid and the ask price
Vertical spreads involve buying one option and selling another on the same stock, with the same expiration month, calls or puts
Credit spread is created when a higher- priced option sold against a purchase of a lower-priced
(0.10 Bid – 0.40 Ask)
Net= 0.30 (debit) or
(0.40 Bid – Ask)
Net =-0.30 (credit)

6. What is a Bear Call Vertical Spread
Investor buys one call and sells another
Same underlying security
Same expiration
Different strike prices
Credit spread is created when a higher-priced option sold against a purchase of a lower-priced

7. Bear Call Spread Example
Wells Fargo stock is at $48.21
Short term forecast: bearish to neutral
Sell 1 WFC Feb 50 Call at $0.57
Buy 1 WFC Feb 52 Call at $0.19
Net Credit $0.38
The short 50 Call main purpose is to generate income
The long 52 Call simply limits the upside risk
Strategy does best when price declines or stays steady
Time element is helping the strategy (time strategy)
Maximum gain is net credit received of $0.38
Maximum loss limited to the width of the spread reduced by the credit received

8. Bear Call Spread Example (cont’d)
Sell 1 WFC Feb 50 Call at $0.57
Buy 1 WFC Feb 52 Call at $0.19
Net Credit $0.38
Breakeven = $50.38
(lower strike price + credit received)
Maximum Profit = $0.38
Maximum Loss = $1.62
(width of spread – net credit received)
ROR = 0.38/1.62 = 23% +
BEP $50.38 (expiration) -

9. Possible outcomes at expiration
Scenario 1 – stock moves further down to $45=> you would collect on whole premium
Scenario 2 – stock at $48.21=> you’d collect the whole premium
Scenario 3 – stock moves up marginally to $50=> you could collect partially or breakeven at $50.38
Scenario 4 – stock closes above BEP of $50.38 => your loss is limited to $1.62

10. Setting up a bear call
Find a stock or ETF (SPU, IWM, XLE or other liquid) >5M daily volume
Technical Analysis
Identify a downtrend (trade with the trend!)
Stock near or at resistance
Choosing expiration and strike prices
Allow for days
Sell at a minimum 5% OTM option, buy the next one up
Technical indicators like Average True Range (ATR) could help you get a sense of the stock price
More bearish investor can choose to sell ATM strike, as a variation
Try to collect at least $0.30 on the dollar (before commissions), more if more aggressive

11. Managing the trade (takeaways)
Start small in the papermoney environment
Use money management rules, don’t risk >1% of account value
Check the trend of the market (S&P 500) and the VIX
If volatility (VIX) is relatively high, options tend to have more premium
Try to avoid trading around earnings
Don’t overact to daily price fluctuations, remember these are time spreads “Let the paint dry before you put another coat of paint”
Close the trade when at least 80% of the credit received is bled out of the spread
Close the 4-10 days before expiration
Monitor daily but adjust once, typically near expiration

12. Bear call spread (review)
Bear call spread is a bearish to neutral strategy
Higher volatility in the market could help
It is a risk-defined income strategy
Margin equal to the width of spread minus the long options is required
Make sure you have free cash available in the case you need to close the position
To close the position you would enter into an offsetting order (buy to close/sell to open)

13. Questions? GEOS@saxobank.com
References: ead.html