Many traders who are new to trading options prefer to keep it simple, usually sticking to straight buying of puts or calls to match their market outlook. But moving from outright options buying and selling to spread trading is not as difficult as it may seem. Here we look at a trade that can be used for trading a bullish outlook with a limited risk options credit spread , which can be substituted for buying options.
The position contains a significant statistical edge, as well as an overall lower risk profile. The "Qs", as they are commonly known, represent the ticker symbol for the Nasdaq Trust, an ETF exchange-traded fund that tracks the Nasdaq index. Traders can buy and sell the Qs if they want to trade the underlying Nasdaq Index, much like futures traders trade futures contracts on the same index.
Option traders, meanwhile, can trade the options on the QQQQ, and these options have exploded in volume since they were introduced. Let's say you believe that you have a medium-term bullish outlook on the market and would like to speculate on this view using options. One approach might be to simply buy two long-dated at-the-money options on the QQQQ, which would have a position delta of about or 1. Suppose you decide you would like to buy two January at-the-money options to go long on the QQQQ.
This would give you unlimited upside profit potential with limited risk on the downside. The QQQQ at the time of writing was trading at Of course, one of the downsides to buying options is risk from time-value decay. Meanwhile, if the move never occurs, and the QQQQ heads lower, the loss of the entire premium paid for the options is possible.
Finding a Better Trading Solution In order to speculate on a bullish move higher, it would be nice to minimize the theta risk mentioned above. Fortunately, there is a way to do this without sacrificing your probability of profit from a statistical point of view. There is only one small, insignificant cost, which comes in the form of a few extra dollars in commissions because you are going to use a spread, which has an extra leg.
Assuming again that the QQQQ is at Here you would pick a deep in-the-money put to sell and an at-the-money put to buy. You are selling two spreads to make the position roughly equivalent to the long calls position shown above. As presented in Figure 3, there is only 1. This is the potential maximum loss if the market heads straight down, or remains below the 39 by expiration.
Now as you can see in Figures 1 and 2, both positions are nearly equivalent in terms of position deltas with the long calls gaining an edge if the QQQQ moves significantly higher , but the theta risk is significantly different. Finally, while not shown here, the probability of profit and expected profit are substantially different from a purely statistical point of view. While, statistically, these trades don't look good overall, if your market outlook is correct and a good move higher occurs, you would be better off with the alternative approach based on this probability perspective.
With a really big move higher, the long calls would acquire more potential profit at expiration. The Bottom Line Given the evidence, it seems that selling an in-the-money put spread on the QQQQ, which could be applied to many individual stocks, has certain key advantages over buying at-the-money calls.
Perhaps most importantly, the cost of being wrong is also higher, for the long calls. So if you are new to trading options, keeping it simple may mean short changing yourself. Consider moving to options spread trades, such as an in-the-money put spread - understanding them may be easier than you expected.
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