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Guest Daddy Bear

Using Put Options - Can U Explain

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Guest Daddy Bear

Is there anyone out there who can explain the strategy below. i have just shorted CWD at 27 £/pt for MAR 06' @ 342.8.

I had to go in today and as i am finding it impossible to time the downturn.

I am riding with a Big risk and high stop loss.

I am only 2 weeks into spread betting - shorting the market with a broker and tax was just to much hassle.

The method below seems to reduce the risk (that i have been forced to take above) but i am at pains to understand it.

Please could somebody explain in basic english step by step guide how to use this method.

It would help if you used a specific share eg countrywide as an example. And specific buys/sells and dates.

I use finspreads (can you use put options with them , if not which spread betting firm offers this practice).

is it better to use a broker? What are the tax implications?

Using Options

Options, specifically a calendar spread strategy, can be used to create a bearish position that helps avoid having to pinpoint the precise timing of the elusive top. A calendar spread, sometimes known as a horizontal or time spread, is used when one anticipates a gradual price move over the intermediate term, say, eight to 16 months.

The benefits of this approach, vs. being outright long or short the stock, are limited risk coupled with potentially limitless profit, and the relative ease with which the position can be adjusted in response to price movement.

A bearish calendar spread involves selling put options with a given strike and expiration date while simultaneously buying put options with the same strike price but a different expiration date. In the bearish case, the expiration date on the purchased (long) puts will be further out than on the sold (short) puts.

In other words, the life span of the puts bought is greater than that of the ones shorted. On Tuesday, with the stock at $50, it was possible to sell the September 45 put for $1.25 and simultaneously buy the January 2007 LEAP put for $6.50, or a net debit of $5.25 for the spread. The cost of the spread -- in this case, $525 per unit -- essentially represents the position's maximum loss. Some situations, such as a takeover in which all the time value of the long-dated options would likely evaporate, could result in the maximum loss in a short period of time

Before explaining how to profit from this calendar spread, let's look briefly at another scenario in which lower prices could actually result in a loss. Let's say that the stock has fallen below $45 a share prior to the September expiration. Assuming you did nothing prior to the expiration date, you would most likely get assigned on your short put options, meaning that the buyers have exercised their option, requiring you, the put seller, to buy shares of Toll Brothers.

At this point you might choose to simply close the position by selling out assigned stock, and sell your long puts. Because the January 2007 puts, with more than 15 months remaining until expiration, would still be awarded significant time premium, the loss would likely be much less than the stated $5.25 risk. But you should be aware that there is a scenario in which you can

Now, here are a couple of scenarios for making the calendar spread profitable, beginning with certain assumptions.

First, if the September $45 put expires worthless, meaning you are now outright long the January 2007 LEAP, one might the look to sell short the next front-month option. Another possibility is that on Sept. 19, the Monday after expiration, if Toll is still trading around $49, you could sell the October 2005 $45 put for around $1.25 per contract. (I used a basic option calculator to arrive at this price.) This will further reduce the cost and risk to $4 per spread.

Theoretically, assuming Toll shares and other variables remain constant, it would take about five option cycles, or expiration months, to pay for the January 2007 puts. Of course, it is likely the stock will change price, and this could either accelerate or lengthen the time period it takes to pay off the initial cost. So depending on how the stock trades, a myriad choices and possible adjustments are possible -- and too numerous to list.

But the concept of continually rolling forward and selling the near-term contract is a way to take advantage of the fact that the rate of time-premium decay accelerates as the option approaches expiration. This will continually raise the break-even point and, as mentioned above, can ultimately create a position that has no cost or risk but an unlimited profit potential with plenty of time on its side

OPTIONS

Options, specifically a calendar spread strategy, can be used to create a bearish position that helps avoid having to pinpoint the precise timing of the elusive top. A calendar spread, sometimes known as a horizontal or time spread, is used when one anticipates a gradual price move over the intermediate term, say, eight to 16 months.

The benefits of this approach, vs. being outright long or short the stock, are limited risk coupled with potentially limitless profit, and the relative ease with which the position can be adjusted in response to price movement.

A bearish calendar spread involves selling put options with a given strike and expiration date while simultaneously buying put options with the same strike price but a different expiration date. In the bearish case, the expiration date on the purchased (long) puts will be further out than on the sold (short) puts. In other words, the life span of the puts bought is greater than that of the ones shorted. On Tuesday, with the stock at $50, it was possible to sell the September 45 put for $1.25 and simultaneously buy the January 2007 LEAP put for $6.50, or a net debit of $5.25 for the spread. The cost of the spread -- in this case, $525 per unit -- essentially represents the position's maximum loss. Some situations, such as a takeover in which all the time value of the long-dated options would likely evaporate, could result in the maximum loss in a short period of time

Before explaining how to profit from this calendar spread, let's look briefly at another scenario in which lower prices could actually result in a loss. Let's say that the stock has fallen below $45 a share prior to the September expiration. Assuming you did nothing prior to the expiration date, you would most likely get assigned on your short put options, meaning that the buyers have exercised their option, requiring you, the put seller, to buy shares of Toll Brothers.

At this point you might choose to simply close the position by selling out assigned stock, and sell your long puts. Because the January 2007 puts, with more than 15 months remaining until expiration, would still be awarded significant time premium, the loss would likely be much less than the stated $5.25 risk. But you should be aware that there is a scenario in which you can

Now, here are a couple of scenarios for making the calendar spread profitable, beginning with certain assumptions.

First, if the September $45 put expires worthless, meaning you are now outright long the January 2007 LEAP, one might the look to sell short the next front-month option. Another possibility is that on Sept. 19, the Monday after expiration, if Toll is still trading around $49, you could sell the October 2005 $45 put for around $1.25 per contract. (I used a basic option calculator to arrive at this price.) This will further reduce the cost and risk to $4 per spread.

Theoretically, assuming Toll shares and other variables remain constant, it would take about five option cycles, or expiration months, to pay for the January 2007 puts. Of course, it is likely the stock will change price, and this could either accelerate or lengthen the time period it takes to pay off the initial cost. So depending on how the stock trades, a myriad choices and possible adjustments are possible -- and too numerous to list.

But the concept of continually rolling forward and selling the near-term contract is a way to take advantage of the fact that the rate of time-premium decay accelerates as the option approaches expiration. This will continually raise the break-even point and, as mentioned above, can ultimately create a position that has no cost or risk but an unlimited profit potential with plenty of time on its side

Thanks in advance for simple explanations

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£27 per point is equivilent to (27 x 340) £9180's worth of exposure to CWD. I hope you have deep pockets if the trade goes wrong. :-o

Having said that, I am short CWD myself and think that it's due a fall back to anywhere between 50p-300p.

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  • 301 Brexit, House prices and Summer 2020

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      • down 5% +
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