Category: Bull Call Spread

Technical analysis can be a big part of your potential success even as an option trader. I truly believe this and talk about technical analysis every single day in my Group Coaching class. A lot of my education focuses on support and resistance. Often a stock needs to move above resistance (if there is any) to make an extended move higher. Since we are talking about bullish bases here, that is one element to make note of. But there is a potential support element that needs to be considered as well. Let’s take a look below.

What Are Bullish Bases?

There are several definitions of bullish bases, but the one I use most frequently really explains how the base forms. A bullish base forms when an underlying moves considerably higher, usually over a short period of time, and then begins to trade sideways. To me, the question becomes, what is sideways and what represents potential support? If the underlying does not pull back more than two-thirds of the move higher, it can be considered a bullish base. In essence, that two-thirds hold acts as potential support as it keeps the underlying from moving lower. For example, if a stock moves from $90 to $105 and then trades sideways and never closes convincingly below $100 (15 (move higher) X 2/3), it has formed a potential bullish base. But at the same time, the stock is stuck under some resistance that it has had trouble trading above, maybe at the $105 level in this example.

It is really showing how strong the buyers are for the particular underlying. This in itself does not guarantee the underlying will move higher. What a trader still wants to see is for the stock to break out above the resistance level of the bullish base. The base sets the tone, but buyers need to continue to push the underlying higher for a bullish directional opportunity.

Examples of Bullish Bases

Let’s consider a couple of examples below on two different time frames. As with most technical setups, bullish bases can be seen on all different time frames. Take a look below at this potential bullish base on an hourly time frame.

The stock rallied from around $363 about 10 days ago and has traded in a range between about $371 and $374 for the past several days. This would be considered a potential bullish base since the stock did not pull back more than a third of its approximately $11 run higher. But just because it set up the potential bullish base does not mean it will move higher as seen below when the chart is extended several more time frames.

The stock gave two head fakes over resistance before retreating lower. Option traders should consider waiting for a concrete break of that potential resistance before entering a bullish trade.

Take a look at the example below using a daily time frame. The red square is the initial bullish base.

Notice the stock moved higher only after a solid bullish candle convincingly moved through the resistance level. This would have been a bullish directional opportunity for an option trader. At the time of this screenshot, the stock was setting up another potential bullish base but resistance had not yet been broken. Patience and opportunity are key.

Finally

Determining what a bullish base is can be fairly easy if you know what to look for and consider. Remember, you want the stock to maintain two-thirds of the move higher. But just because it is a bullish base does not mean it will eventually move higher. Resistance like support (which holds up the bullish base) still has a better chance to keep the stock from moving higher. As traders we always want to put the odds on our side. For me, that would be a break above the resistance level particularly when it forms a bullish base.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

A topic that is brought up more often than you might think in my Group Coaching class is buying outright call options and put options. When option traders first learn about trading options, they often only consider buying call options for a bullish outlook and put options for a bearish outlook. I know I did as a young retail option trader. In their and my defense, we were new so not knowing advanced strategies limited the option strategies available to trade. Choosing to buy call options and put options is the most basic of all option strategies, and more often than not it may not be the best choice.

What Are Call Options?

When an option trader buys a call option, he or she has the right to buy the underlying (usually stock or an ETF) at a particular price (strike price) before a certain time (expiration). Keep in mind that just because the option trader has the right to buy the underlying, doesn’t mean he or she has to necessarily do so. The call option just like a put option can be sold anytime up until expiration for a profit or loss. When selling a call option, the option trader has the obligation to sell the underlying to the buyer at the strike price up until expiration if he or she desires to do so (called exercising their right).

What Are Put Options?

When an option trader buys a put option, he or she has the right to sell (or sell short) the underlying (usually stock or an ETF) at a particular price (strike price) before a certain time (expiration). As is the case for the owner of a call option, just because the option trader has the right to sell the underlying doesn’t mean he or she has to necessarily do so. The put option can be sold anytime up until expiration for a profit or loss. When selling a put option, the option trader has the obligation to buy the underlying from the buyer at the strike price up until expiration if he or she desires to do so (exercising their right).

Examples of Short-Term Call Options

Option traders may fall in love with call options and especially short-term call options because they are cheaper than call options with longer expirations. We can classify short-term call options as call options that expire in three weeks or less for the sake of this discussion. But there is a potential problem with purchasing short-term call options. The shorter the amount of time that is purchased, the higher the option theta (time decay) will be. The higher the time decay, the quicker the premium will erode the call option’s premium. The call option may be cheaper due to a shorter time until expiration, but it may not be worth it overall. This is another example of a trade-off in option trading. The more time till expiration the more expensive the option and higher the risk, but the time decay will be slower. The shorter the expiration the cheaper the option and lower the risk, but you will have faster time decay.

Example of an Outright Call Option

With the stock trading at $43.43, an option trader has done his research and thinks the stock will move higher over the next couple of weeks. He looks at the option chain and considers buying a 40 strike call for either January or February expiration as seen below.

He could have purchased the Dec-24 calls for 2.15 that expired in 9 days. Yes, the options are cheap in comparison to the February options below and, yes, they will profit if the stock moves up vigorously in the next couple of days. But the option theta is -0.16 (rounded up) on the call options meaning they will lose $0.16 for every day that passes with all other variables being held constant. In fact, if the stock trades sideways, the option theta will increase the closer it gets to expiration since there is currently no intrinsic value (the in-the-money portion of the option’s premium) on the call options.

If an option trader purchased the February calls, it would have cost him 7.60 and it would have made the at-expiration breakeven point of the trade $52.60 (45 + 7.60) versus only $47.15 (45 + 2.15) with the Dec-24 call options. But the major benefit to buying further out is option theta. The February 45 calls had an option theta of -0.06 (rounded down), meaning for every day that passes the option premium would decrease $0.06 based on the option theta and all other variables remaining constant. This is certainly a smaller percentage of a loss based on option theta for the February options (0.8%) versus the Dec-24 options (7.4%) especially if the stock trades sideways or moves very little.

In addition, the February calls have a positive delta of 0.57 and would gain about $57 for every $1 the stock moved higher. The Dec-24 calls would only gain about $44 from a $1 move higher based on the positive 0.44 delta for the same 45 strike. Bigger positive delta and smaller negative theta on the February calls seems tough to beat.

Wrapping This Up

Having enough time until expiration is a critical element when an option trader is considering buying options like the call options we talked about above. Keep in mind that as a general rule, options lose value over time and the option theta starts to accelerate even more with 30 days or less left until expiration. Buying a call or put option with more time until expiration will certainly cost more than one with less time but the benefits, including having a smaller option theta and most likely a bigger delta, might be worth the more expensive price especially if the underlying fails to move much.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

One of the big stock market stories of 2020 was the domination of so-called Work-From-Home Stocks. While some companies lost massive share value last year, these work-from-home stocks skyrocketed. But what happens after COVID? Can some of these stocks continue to climb? I think they can.

To understand why, let’s take a trip through innovation history for a moment. The story begins back in 1994 in Bellevue, Washington, with the birth of Amazon.com. A nerdy guy with a funny laugh named Jeff Bezos came up with the somewhat novel idea of creating an online bookstore. Within four years Bezos and his team had expanded into music, video and consumer goods. And then, well, Amazon basically took over the world.

But the key element of the story for our purposes is the “delivered to your door” aspect the company arguably invented and then unarguably mastered—basically showing the world it’s possible and how to do it. From 2000 to 2020, many companies claimed their stake in the burgeoning cottage industry catering to, well, cottage industries and agoraphobes to boot. 

This sector had been growing for a long time even before the pandemic hit. Many of the companies in this niche already had solid business plans in place and in practice for home shopping and the remote-working economy. The pandemic merely accelerated the pace of expansion out of necessity.

Many companies have the opportunity to thrive from catering to the work-from-home crowd. These are four notable stocks I think will continue to rally even after vaccines and herd immunity bring the world back—or at least return it closer—to normalcy.

Zoom Video Communications stock (ZM)

Now a proprietary eponym for any remote video meeting, Zoom was the incontrovertible pandemic darling. Ah, yes. Looking back at mid-March of last year, the excitement of watching Zoom’s stock price blast higher almost balanced out the terror of the realization we were heading into the first major global pandemic in around 100 years.

After hitting an all-time high on Oct. 19, 2020, ZM pulled back and entered a downtrend. But the past two weeks saw the establishment of a new level of support, with more support at the 200-day moving average.

Zoom has faced competition, including Google temporarily offering a streamlined competing product for free. And its lightning-fast growth had some obstacles to overcome—“Zoombomb” is a new word in the dictionary as of 2020. It also was possibly a bit overbought in the hype during the fall. But is that business going away anytime soon or ever? No. And Zoom has established itself as the dominant player and has to defend its title for the sake of its investors. It is Damocles-like pressure being king of video meetings. But, hey. That’s what corporations do.

This stock likely will have growth potential for a long, long time, as many companies have moved toward allowing their employees to work, at least part of the time, from home (Twitter, Adobe, Amazon, Capital One, etc.).

DoorDash stock (DASH)

Hugely exciting IPO.

And then…

But then!…

There aren’t enough trading days for any reliable technical data on this company. And there are a lot of naysaying haters out there. But aren’t there always?

The thing I like is that there’s a lot going on under the surface. Zoom hires people with a spare car and more spare time to deliver food to you. But it’s savvy and strategic. The company decided to own the suburbs—and does—or at least 58% of suburban areas in the U.S. That’s up from 23% in January 2018. It’s expanding delivery into other things besides food. And it’s been working on autonomous cars for years now. Oh, and it looks like it will be first to market in the densely populated, COVID-stricken Japanese market.

This one can catch some wind in its sails.

Docusign stock (DOCU)

This remote signing company was well positioned going into 2020. Then contract signers in corporate America had to stay at home with their pens to avoid The Rona. What to do? Digital documents to the rescue! The pandemic was the shot in the arm to propel Docusign to the next step toward its destiny faster than planned.

Last quarter’s earnings surged 53% year over year to reach $382.9 million. It’s growing and it knows it. This past week it secured a new $500 million senior secured revolving credit facility. And it will offer $500 million of convertible senior notes maturing in 2024.

Airbnb stock (ABNB)

I have to give this online home sharing marketplace at least an honorable mention.

A work-from-home stock? Well, kind of. I’d say part of what has helped it lately is being more a “work from anywhere” stock. And that’s just what a lot of gig employees are doing. City-dwelling workers have opted to get out of Dodge (or Chicago or New York) and head to the ’burbs or rural areas with their laptops. I mean, if you’re going to quarantine, do you want a condo in New York City with another 8.4 million of your closest friends or a quiet ranch in Colorado with a view of Pikes Peak? Not to mention these questing quarantiners often stay for two weeks or longer (a typical stay otherwise is four to seven days).

What’s more, home rentals have outperformed hotels in 27 global markets since COVID started. And rental rates were higher this summer than last. To be fair, travel has been a tough biz since last year. But if you’re going to be in this business, it’s good to be Airbnb with more than 7 million listings in over 220 countries—the biggest of all.

Plus, the company was as nimble as the best of them. Airbnb laid off a quarter of its workforce in the spring to manage costs and got into some tangential businesses like transportation and entertainment. It seems to have some vision and this model isn’t going anywhere.

Key Stock Market Data

I watch these stocks (and own or trade them with options) daily. They’re on my radar and watchlists. While one can lean bullish or bearish on option plays, I’m always looking for dips to potentially take some positive delta plays. And, of course, watching their earnings will provide key insight into what may come. As many of our traders know, earnings are a big thing at MTM. They provide huge insight on value and can create great trading opportunities as well.

Dan Passarelli
Founder and President
Market Taker Mentoring, Inc.

With the next round of quarterly earnings just about to start, it is a good time to take a look at trading options and in particular cash-secured puts. Option prices (implied volatility levels) tend to increase around an expected earnings report. This could be potentially good (if traded correctly) for premium sellers and not so good for potential buyers. The reason is option prices (implied volatility) tend to decrease after the earnings announcement. Again, good for sellers potentially and no good for buyers because option prices will decrease.

When option traders first discover the strategy of selling “naked” options, they sometimes get enamored with the concept especially over earnings and some might consider it to be low risk too. It really isn’t in my opinion and can be quite harmful to your trading account. Writing or selling naked options is selling options without having a position in the underlying stock or being long any options on the stock. For example, if a trader is writing naked calls, he is selling calls without owning the stock. If the trader did own the stock, the position would be considered “covered” or a covered call.

Is There Such a Thing as a Low-Risk Option Trade?

Option traders often think that it is a low-risk strategy that can offer consistent profits and indeed it can. However, selling naked options can be dangerous especially for new option traders and should be considered only by more advanced option traders and those with large trading accounts.

Short option premium can seem like an easy way to make a profit in trading. What traders forget is that the premium received from selling options is not theirs to keep until the position is closed for a profit or it expires worthless. Even though the premium may seem like a gift, it isn’t. The risks of selling options can be significant.

Implied Volatility and Earnings

With the recent rise in the market and earnings season upon us, the implied volatility of many options has increased making it more tempting to do so. When implied volatility is considered high, it can be a good time to sell premium like a naked option. Generally, after the announcement, the implied volatility starts to decline as mentioned above, which is good for sellers of premium and naked option traders. That being said, it is also considered even more speculative if the position was held over the earnings announcement. A volatility event like an earnings announcement can produce some unpredictable price action for stocks. Just take a look at a few daily charts like Jumia Technologies (JMIA), Nio Inc. (NIO) and Quantumscape Corp. (QS) to name a few.

Netflix Example

Here is an example using Netflix Inc. (NFLX). The stock was acting volatile over the past several weeks and was expected to announce earnings in about two weeks at the time of the screenshots below. It was trading around $509 at the time of this writing, and it had a potential support levels starting around the $480 level (200-day SMA) all the way down to some pivot levels at $470 as seen below. If the 470 put strike was chosen, that means the stock was trading almost $40 from the strike. But as you can see on the left of the chart in the red box, the stock had moved more than that in the past in that time frame.

The company was also expected to announce earnings Jan. 19, which is always subject to change. An option trader could sell 10 Jan-22 (expiration after earnings) 470 puts for 6.40 each as seen below and would potentially have two support levels for the stock.

As long as NFLX stays at or above $470, the premium of $6,400 (640 X 10) would be the trader’s to keep. In fact, NFLX could even drop a little below the $470 level and the trader could profit. The premium offsets potential losses and makes the breakeven point of the trade $463.60 (470 – 6.40).

Potential Huge Option Trading Losses?

That is all well and good, but many option traders fail to limit their losses when the stock moves against them or just can’t because the stock drops so much after the announcement. Depending on the move particularly after earnings, many naked option positions can wipe out a significant part of traders’ accounts. What many traders fail or forget to realize is that each option contract usually represents 100 shares of stock. In the example above, if NFLX announced perceived horrible earnings or guidance and the stock traded down to $650 ($20 below the strike, which is possible as seen above) at expiration because of earnings, a loss of $13,600 ((10 X 2000) – 6,400) would be incurred because of the 10 contracts. An almost sure thing has now become a sizable loss.

Final Word

Like many things in life, the “sure thing” is not a guarantee. This is so true for option traders and expected earnings announcements. Sometimes a positive announcement is met with a drop in the stock price and vice versa. There is a way to get an edge usually options and implied volatility, but just selling “naked” options might not be one of them or one of them for you.

For more on how earnings trading can be your most profitable trade, register here for a complimentary webinar on Jan. 13 presented by MTM founder and president Dan Passarelli.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

Option traders often ask me is there a way that you can take advantage of this bullish investing scenario while limiting risk? Certainly, there are a few option strategies that can accomplish this goal. One that may be an option (no pun intended) is a debit call spread, which is sometimes referred to as a bull call spread. Another is a credit put spread, which is sometimes referred to as a bull put spread. Let’s take a quick look at both bull call spreads and bull put spreads.

What Are Bull Call Spreads?

When implementing a bull call spread, an option trader purchases a call option at one strike and sells the same number of calls on the same stock at a higher strike with the same expiration date. The position can generally profit if the stock moves higher. Let’s take a look at a hypothetical stock and situation with ABC Inc. (ABC). The stock moved up and closed at $122 and formed a bullish base.

Bull Call Spread on ABC

The trader’s maximum profit on a bull call spread is limited; he can make as much as the difference between the strike prices less the net debit paid. For simplicity, let’s assume that at the time one April 120 call in-the-money (ITM) was purchased for 3.00 and one April 123 call out-of-the-money (OTM) was sold for 1.00 resulting in a net debit of $2 (3 – 1) ($200 in real terms). Max loss would be realized if the stock closed at $120 or lower at expiration. April expiration was about a week away. The difference in the strike prices is $3 (123 – 120). He would subtract $2 from $3 to end up with a maximum profit of $1 ($100 in real terms) per contract. So, if he traded 10 contracts, he could make $1,000 (10 X 100). He would need the stock to move a dollar or more higher ($123 or higher) by expiration to realize the maximum profit ($1).

Although he limited his upside profit potential, the trader also limited the downside to the net debit of $2 per contract. To simply break even, the stock would have to stay at its current price of $122 (the strike price of the purchased call (120) plus the net debit ($2)) at expiration. Effectively, the trader has created a theta (time decay) neutral position at the onset of the trade since he would break even if the stock never moved a penny off its current price of $122. The same could not be said of a long call position. A long call always has some type of negative theta meaning that for every day that passes, the option premium will get smaller due to the passing of time.

Bull Call Spreads and Long Calls

When trading the long call, a trader’s downside is limited to the net premium paid. If he simply purchased the ITM April 120 call, he would have paid $3. The potential loss is, therefore, greater when implementing a call-buying strategy. If he had moved to a call with a longer time frame to expiration, he would have even paid more for the option. This would also increase his potential loss per option as well. By implementing a bull call spread, traders can hedge their bets, limiting the potential loss. In addition, buying an ITM debit spread like the bull call can offset time decay (theta). A long call or put position cannot be structured to offset theta completely. These are a few of the advantages when comparing purchasing options outright to spreads as in this case, a long call to a bull call spread.

What Are Bull Put Spreads?

When implementing a bull put spread, an option trader sells a put option at one strike and buys the same number of puts on the same stock at a lower strike with the same expiration date. The position can hit maximum profit if the stock stays at or above the short put strike at expiration. Let’s again take a look at the hypothetical situation with ABC Inc. (ABC) from above. The stock moved up and closed at $122 and formed a bullish base. The option trader is not sure if the stock will move much higher but thinks the stock will at least stay above the $120 level by expiration. In essence, he wants to be able to profit in three out of four ways. The stock can move higher, trade sideways or drop a little and he can still profit. With this scenario comes a risk/reward that may not be friendly. Let’s take a look below.

Bull Put Spread on ABC

The trader’s maximum profit on a bull put spread is once again limited; he can make as much as the credit received for the position if the put options expire worthless at expiration (in this case $120 or higher). For simplicity, let’s assume that at the time one April 120 put OTM was sold for 2.00 and one April 115 put OTM was bought for 1.00 resulting in a net credit of $1 (2 – 1). The $1 ($100 in real terms) is the max profit. April expiration was about a week away in this scenario. The difference in the strike prices is $5 (120 – 115). He would subtract $1 from $5 to end up with a maximum loss of $4 ($400 in real terms) per contract. This would be realized if the stock closed at $115 or lower at expiration.

Just like with the bull call spread example above, the option trader has limited his upside profit potential of $1 a spread. The position also limits the downside to $4 per contract. For the position to close at breakeven, the stock would have to close at $119 (the short strike (120) minus the net credit ($1)) at expiration. Effectively, the trader has created a positive theta (time decay) position at the onset of the trade because if the stock never moved a penny off its current price of $122, maximum profit would be realized at expiration due to the positive theta of both options eroding and becoming worthless at expiration.

How Does Implied Volatility Affect Bull Put Spreads?

Implied volatility (IV) by definition is the estimated future volatility of a stock’s price. More often than not, IV increases during a bearish market and decreases during a bullish market. The reasoning behind this comes from the belief that a bearish market is riskier than a bullish market. The jury is still out on whether this current bullish market can continue through the summer but regardless, now may be a good time to review a strategy that can take advantage of higher implied volatility even if it doesn’t happen this week. Option traders need to be prepared for all types of trading environments.

Selling bull put spreads during a period of high implied volatility can be a wise strategy, as options are more expensive and an option trader will receive a higher premium than if he or she sold the bull put spread during a time of low or average implied volatility. In addition, if the implied volatility decreases over the life of the spread, the spread’s premium will also decrease based on the option vega of the spread. Option vega measures the option’s sensitivity to changes in the volatility of the underlying asset. The implied volatility may decrease if the market or the underlying moves higher.

Final Thoughts

Bull call and bull put spreads are similar in the fact that they are both bullish in nature to some degree. The bull call spread generally needs the underlying to move higher to profit. The advantage of a correctly implemented OTM bull put spread is that it can profit from either a bullish, neutral and sometimes bearish move. A bull put spread can also take advantage of higher implied volatility levels that can result in a greater premium received on the spread, which in turn creates smaller risk as well.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc. bull