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The Bear Put Spread is set up by buying a Higher strike Put while simultaneously selling a LOWER strike Put, both with the SAME expiration date.  The Bear Put Spread is a Debit Spread, meaning you will pay a higher price for the Put that you purchase than the price of the Put that you sell.

In order to enter this position the investor will have some beliefs.

          1)  She believes that the underlying security will stay the same or go down.  Depending on the strikes chosen, the underlying security can go up a little and this position will still make money.  That is why this position has the word Bear in the name, it has a bearish bias.

          2)  The investor understands that IF the underlying stock moves counter to the postion, in this case, up, the position can lose 100% of the money invested.  The good thing about a vertical spread, however, is that the options WILL retain some value, up until, expiration.  This means that a 100% loss can be avoided. 

Lets look at an example:

Lets assume that GE (General Electric) fits the criteria.  GE is trading for $10.78 on March 27, 2009.  I would buy an April 2009 $12 Put, for $1.55, while selling an April 2009 $11 Put, for $0.90 .  Here is the Risk/Reward graph for this position.

 

Bear Put Spread - GE

The Maximum Loss is $0.65 (+ Trading Costs), and this will occur if GE is above $12 at the expiration, April 18, 2009.

The Maximum Gain is $0.35 ($1 difference in strikes -$0.65 premium paid) (- Trading Costs), and this will occur if GE is below $11 at the expiration, April 18, 2009.

If GE is between $11 and $12 at expiration, April 18, 2009, then the gain/loss will be -$0.65 (the cost of the spread) – the price of GE + $12 (the price that you can sell (put) GE).  Therefore the breakeven point for this position is $11.35 (-$0.65 – $11.35 + $12 = $0) (not including trading costs).

This trade would be entered when GE was trading for $10.78.  This means that if GE stays the same or goes down OR goes up $0.22 (2.0%) this position will still make the maximum gain.  GE has to go up to $11.35, a gain of $0.57(or 5.3%), for this position to start to lose money. 

This position cost us $0.65/share and has an upside potential profit of $0.35/share.  That would be a 54% gain in less than 1 month.  Which is an approximate 650% APR (Annual Percentage Rate).

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The Bull Call Spread is set up by buying a LOWER strike Call while simultaneously selling a HIGHER strike Call, both with the SAME expiration date.  The Bull Call Spread is a Debit Spread, meaning you will pay a higher price for the Call that you purchase than the price of the Call that you sell.

In order to enter this position the investor will have some beliefs.

          1)  She believes that the underlying security will stay the same or go up.  Depending on the strikes chosen, the underlying security can go down a little and this position will still make money.  That is why this position has the word Bull in the name, it has a bullish bias.

          2)  The investor understands that IF the underlying stock moves counter to the postion, in this case, down, the position can lose 100% of the money invested.  The good thing about a vertical spread, however, is that the options WILL retain some value, up until, expiration.  This means that a 100% loss can be avoided. 

Lets look at an example:

In a previous Trade Idea I suggested a Vertical Spread.  I said to buy a July 2009 $35 Call while selling a July 2009 $55 Call on SRS  (Proshares Ultrashort Real Estate Fund).  Here is the Risk/Reward graph for this position.

SRS - Bull Call Spread

The Maximum Loss is $7.80 (+ Trading Costs), and this will occur if SRS is below $35 at the expiration, July 18, 2009.

The Maximum Gain is $12.20 ($20-$7.80) (- Trading Costs), and this will occur if SRS is above $55 at the expiration, July 18, 2009.

If SRS is between $35 and $55 at expiration, July 18, 2009, then the gain/loss will be -$7.80 (the cost of the spread) – $35 (the price that you can buy (call) SRS) + the price of SRS.  Therefore the breakeven point for this position is $42.80 (-$7.80 – $35 + $42.80 = $0) (not including trading costs).

This trade was entered when SRS was trading for $59.44.  This means that if SRS stays the same or goes up OR goes down $4.44 (7.5%) this position will still make the maximum gain.  SRS has to drop to $42.80, a loss of $16.64 (or 28%), for this position to start to lose money.  The 52 week low for this ETF is $48.00.

This position cost us $7.80/share and has an upside potential profit of $12.20/share.  That would be a 256% gain in approximately 6 months.  Which is an approximate 500% APR (Annual Percentage Rate).

One other note on this example:  This position is called a Bull Call Spread, that means that I was “bullish” on SRS.  However, SRS is an “Ultrashort” ETF, which means that it moves up when some index, in this case the real estate fund, goes down.  In essence, this position was a “bearish” position.  I hope I have not confused the situation.

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