Q&A |
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How Credit Put Spreads Work?Wednesday, May 3, 2006, 7:26 AM ETQ.How Credit Put Spreads Work? Give an example. Example:
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1. Why we bet on Google? There were several reasons for this. · The GOOG stock has formed a bottom above the 400 line (see below). · It had the downside protection of $15 with very low chances to loose it within the next 5 days. · Put spreads were overpriced because the implied volatility was very high.
Chart courtesy of StockCharts.com In fact, our bet was as follows. We invested $900 for one contract (or $9/option) and anticipated to receive $100 ($1/option) in 5 days. 2. Why credit put spreads? Credit put spreads give you very good chances to benefit from overpriced put options. Why these options were overpriced? It happened because influential option traders use traditional option-pricing models that almost disregard technical signals. All we had to do was just to live through the next 5 days to expiration. The beauty of credit put spreads is that time is on our side.
Finally, we finished that week with both options expired out-the-money. Hence, the initial credit of $100 successfully remained in our hands. We have delivered to our subscribers the 11% gain in 5 days!
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