Swinging Option Spread Trading

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Options Trading Topic: Swinging Option Spread Trading

Dear Options Trading FAQ:

In the past year I've played many bull spreads, several times buying back the short options when the stock bottoms and reselling it when the stock is back up. I use bull spreads mainly to handle such unexpected drops such as the one that happened to MSFT, dropping from 100 to 81. I established the MSFT Jan 100, Jan 110 call debit spread when MSFT was around 96 (Buying the 100 Call options and Selling the 110 Call options for a net debit amount). When the stock dropped to 81, I bought back the Jan 110 to close the position. I then sold the Jan 110 back out to open when MSFT went back up to 100 and my exposure is now much less.

What do you think of this option strategy? Can I do this over and over? I know this only works for volatile stocks and also with low commissions.

Busy Option Spreader
Dear Maybe a Little too Busy with the option trading:

Just one question - when the short call falls in price so that you want to buy it back, doesn't the long side fall in value too? In your example, you bought to close the 110 call option when the stock hit 81. What was the value then of the 100 call that you were long? Not much, I would guess. The paper loss at that time must have been severe. It was a good play to close out the short side because the stock rebounded, putting good premium back into the long 100 call.

At this point many would have chosen to sell out the long side, flattening the position and salvaging the trade. That would be an example of a classic successful legging out of a troubled spread.

Here though you choose to re-spread the whole affair by selling the 110 call option again. I suppose it is because your original bullish outlook on the stock has been restored, but aren't you asking for a bit of trouble? In the time it took for all this to transpire, haven't you lost a bit of premium from your long call? Wouldn't a simple stop strategy have meant much less exposure from the start? If the stock had not come back, the spread would have been a complete loss.

It sounds like you're caught a little bit in the fact that you can make some short term money in the short side of the spread. Don't forget that in this and all spread strategies, you are "supposed to" lose money on one side. Don't fall into the trap of trying to make both sides profitable. It seems like you are cheering for the short side to come down so that you can buy it back to sell it again later. Well, don't wish for that because, theoretically, your debit spread in calls demands a swift, strong upmove.

I have a client who loves to try to make money on both sides of an option spread. An eternal optimist with his positions, he doesn't care which way he is spread, bullish or bearish. First he'll root for the net long side and then break the spread to cheer for the other side. Action is his game - he'll take it in whatever fashion it happens to appear in.

Let's try to be a little more controlled than he. I think you sense the concerns I've voiced, because you allude to needing low commissions and an active stock.

Just don't get carried away. If you want to play swings in the stock, use simpler strategies - buy plain calls for a rally and puts for a decline.
Often times the simplest things work the best.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Option Spreads, Options Strategy

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