I’ve given you a taste of the way I trade options already, and I want to show you another strategy that I love to utilize.
Today, I want to draw back the curtain to reveal how I define my edge in the options market…
Using what I believe to be a simple strategy.
You see, this strategy lets me know the odds right off the bat…
Of course, they can change, but I have an idea of the likelihood of the outcome.
Not only that, but my risk is defined… and I don’t necessarily need the stock to move to my favor.
So what are the specifics behind this strategy, and why do I believe traders should learn it and have it in their arsenal?
How I Use Options Spreads To My Advantage
When it comes to options spreads…
I’m looking to place either bullish or bearish trades.
Take a look at a quick run-through of what I’m referring to below.
Now, if this all sounds confusing at first… don’t let that stop you from learning a new strategy.
You see, this was once all new to me at first, but once I started to figure out how beneficial it was for me, I stuck to it.
Let me show you how I actually find how I actually the strike prices in which I want to use a bear call spread or bull put spread.
One way to do that is with probabilities and key levels.
How I Select Strike Prices
Well, on thinkorswim, there is actually a way to show “Probability OTM”…
In other words, the probability (or chance) that a specific options series expires out of the money… or worthless.
For example, here’s a look at some of the options for the calls expiring in just 7 days at the time, in Apple Inc. (AAPL).
Source: thinkorswim
With options, there are buyers and sellers…
The sellers actually take advantage of the probabilities here.
For example, AAPL closed around $350 that day…
If you notice in the yellow rectangular area, there is actually value here on some of these trades, even though there is a high probability AAPL can expire worthless for some of these calls.
For example, the $370 strike price calls were $0.60 bid X $0.73 ask that day…
And there was a 91.73% chance those options can expire worthless by the expiration date.
Can AAPL continue higher?
Sure…
But will it close above $370 in just one week?
Who knows…
But the odds of that happening is very slim, according to the Probability OTM here.
On the flip side, here are the puts.
Source: thinkorswim
Some of these puts still have a lot of value. For example, the $310 puts closed at $0.30 bid X $0.51 ask…
The probability of AAPL closing below $310 are pretty slim.
In fact, if you look above, the probability of AAPL staying above $310 in just a week was a whopping 95.17%.
Of course, there is a chance AAPL can close below that, but it’s pretty slim.
Another way I find strike prices is by looking at key levels. I’m looking for areas in which a stock has had a tough time breaking below (this indicates there’s demand for the stock) or an area where I don’t believe the stock can break above.
It’s similar to placing a trade that says, I don’t think the stock will get there before the expiration date.
With the bull put or bear call spread, I can express my opinion on a stock and collect options premium while placing myself in a position to win in three different scenarios.
Let me show you how I actually use one of these strategies.
Take a look at this daily chart in NVIDIA Corporation (NVDA).
Source: Finviz
At the time, some traders may have been thinking… “Well, NVDA has come a long way from March lows… I think it has a pullback soon.”
To establish that bearish opinion, these traders may look to buy out of the money puts.
I mean take a look at some of the options prices on NVDA puts expiring in just a week’s time (on the right-hand side of the image below), when the stock was trading near $370.
The $350 strike price puts were $4.05 bid X $4.25 ask.
Source: Nasdaq
That means NVDA would need to drop below $347 just for whoever is buying those options to break even…
In other words, they would need the stock to move nearly 10% lower just to not lose money.
Now, I actually enter a bull put spread in NVDA yesterday…
I sold to open NVDA June 26 $365 / $360 put spread for $2.10. This is known as the bull put spread.
I figured since NVDA was so strong… the stock would likely stay above that level.
That specific trade had high odds, in my opinion.
Well, guess what happened…
NVDA shares ran higher that day, and I was actually able to close out that bull put spread.
That was a near $4,000 winner on that bet.*
Those are the types of bets I’m looking to take… and the bull put spread, as well as the bear call spread, are two strategies you’ll be hearing from me about a lot.
If you’re puzzled about this at first… don’t worry, I was too at first. It may be helpful to paper trade at first while you’re still learning the ropes.
Along the way, I’ll provide you with tips and tricks that I believe can be helpful, and other lessons about this strategy… as well as real-money case studies.
Listen, options spreads are just another way to gain exposure to large-cap stocks. If you’re more comfortable using simple calls and puts, then feel free to do that.
For example, if I want to use a bull put spread, the alternative would be to use a call. On the flip side, if I want to use a bear call spread, I could just purchase puts.
*Results presented are not typical and may vary from person to person. Please see our disclaimer here: ragingbull.com/disclaimer