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Over the past year it has become more
difficult to generate profit and increase value to an investor’s portfolio.
Gone are the days of “throwing magic darts at the stock page.” How can an
investor profit from the current “sideways market conditions” or protect
themselves from a possible downturn in the market without much effort? I
believe that if the investor looks into stock index options, they might find
additional strategies to help them along their investment path.
Why Stock Index Options?
Because stock indexes tend not to be as
volatile as individual stocks. And options on the stock indexes such as the
S&P 500 are very liquid, allowing for less slippage in pricing. Using stock
index options, and credit spreads, an investor can possibly generate monthly
income, as well as help offset losses in their stock portfolio. These
strategies can be used for risk management, and be tailored to fit a
bullish, bearish, or neutral market outlook.
What is a Credit Spread?
A credit spread consists of two options of
the same type (2 calls or 2 puts) and the same contract month expiration.
You sell one option at a particular strike price, which you collect premium
for, and you buy another cheaper option at the same time. This limits your
risk on the option you sold. Because you are selling a more expensive
premium option than the one you are buying, you take in a credit. Your risk
is the difference between the two strike prices, less the net premium you
collected, plus commission and fees for placing the trade. By placing the
trade as a spread, you never expose yourself to unlimited risk.
The objective of selling option spreads is
that both options expire worthless and you get to keep all the premium
collected from the sale. It is a way to take advantage of time decay in a
limited risk strategy. |
