Option Strategy Explanation 02 |How to amplify the return through the option strategy

Tiger_Academy
2023-05-12
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Hello everyone!

Today, I'm here to introduce a strategy that can help us amplify investment returns: Bullish options spread strategy.

When should we use this strategy? It's already May, and many U.S. listed companies will disclose their financial statements. Typically, how will stock prices react to financial reports?

Based on my analysis, there are three possible scenarios:

  1. Exceeding expectations: the stock price experiences a significant or moderate increase.

  2. Within expectations: the stock price experiences a moderate increase or decrease.

  3. Below expectations: the stock price experiences a significant or moderate decrease.

We can see that if the financial performance is mediocre, and the results are within expectations or slightly better than expected, the stock price is likely to have a moderate increase.

In this scenario, holding stocks will provide limited returns. However, if we use options strategies, we can potentially amplify our gains while controlling losses. So, how can we operate this strategy?

1. What is the bullish option spread strategy?

The bullish option spread strategy refers to buying a call option with a lower strike price, denoted as K1, at a premium of P1 and simultaneously selling a call option with a higher strike price, denoted as K2, at a premium of P2.

When the stock price moderately rises in the future, the purchased call option with a lower strike price is likely to be exercised and the sold call option with a higher strike price is expected not to be exercised, which reduces the cost of the option strategy.

Assuming the future stock price is S, the profit of this strategy is calculated as (S-K1)*100-(P1-P2) *100when the stock price rises moderately within the range between K1 and K2, where 100 represents the number of shares covered by one option contract.

If the stock price falls below K1, neither of the options will be exercised and the net profit will be P2-P1.

If the stock price rises above K2, both options will be exercised, and the profit will be (K2-K1)*100+(P2-P1)*100.

2. How to implement the strategy in practice

Assuming the current stock price of Starbucks is around $107, if we expect the stock price to increase slightly to between $108 and $110 after the financial report is released, we can choose call options that expire on May 12th as the underlying asset for this strategy, with exercise prices of $108 and $110, respectively.

Data source:Tiger trade app

The specific operation is to buy a call option with an exercise price of 108 at a cost of $0.65 and sell a call option with an exercise price of 110 at a premium income of $0.21. The net premium expense is $44 ($0.65-$0.21)*100.

Assuming the stock price rises to $109 on the exercise date, the call option with an exercise price of 108 will be exercised, while the call option with an exercise price of $110 will not be exercised. The total profit is ($109-$108)*100-$0.44*100 = $56.

Therefore, as long as the stock price is within the predicted range, it is highly likely to be profitable.

But what if the stock price ends up outside the predicted range, such as rising to $115 or falling to $50?

If the stock price rises to $115, the call option with an exercise price of 108 will be exercised, with a profit of ($115-$108)*100=$700, while the buyer of the call option with an exercise price of 110 will also exercise, resulting in a loss of ($115-$110)*100=$500. After considering the net premium expense, the final profit is $156.

If the stock price falls to $50, neither call option will be exercised, and the maximum loss is the net premium expense of $44.

Summary:

  1. If the stock price rises to $109, the total profit is $56.

  2. If the stock price rises to $115, the total profit is $156.

  3. If the stock price falls to $50, the total loss is $44.

In the same scenario, if the investor holds Starbucks stocks at a cost of $107, the returns in the three cases are as follows:

  1. If the stock price rises to $109, the total profit is $2.

  2. If the stock price rises to $115, the total profit is $8.

  3. If the stock price falls to $50, the total loss is $57.

Obviously, the option strategy is far more profitable than holding stocks in all three cases.

So, if you learn how to use option strategies in different scenarios, you can greatly reduce your investment risks and amplify your investment returns. Have you learned it yet?

That's it for today's sharing. If you want to learn more about option-related knowledge, please follow the introductory course on options. We will continue to discuss this topic in the future.

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Investing carries risk. Not financial advice. Published by Tiger Fintech (NZ) Limited (NZCN: 8187510)

All information is for informational purposes only and no investment advice is made. Tiger Brokers Australia does not offer short options and most portfolio strategies. Options trading involves a high level of risk and is not suitable for all investors. You should only invest the amount that you can afford to lose. Before making any investment, please confirm that you have read and understood the Financial Services Guide, Options Product Disclosure Statement and Target Market Identification Letter contained on the website. Tiger Brokers (AU) Pty Limited AFSL 300767

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