Chris Rowe

   

3 TIPS TO GET YOU STARTED TRADING VERTICAL PUT SPREADS

1) When people such as brokers -- who will benefit from you conducting these trades in larger quantity or trading more frequently -- talk to you about this, they might only focus on the fact that, in our last example, you are only committing $800 to make $200 -- a 25% gain in a month. That sounds quite appealing.

But make no mistake; you are risking $800 to make $200 as compared to owning OIH, where the risk of the required cash balance (margin) is less. Although the odds of success increase tremendously with a vertical put spread, we are using leverage. And don't let anyone convince you otherwise.

2) Because of the leverage factor, I prefer to use options on an ETF or index for vertical put spreads. This is because individual stocks are much more likely to lose 50% in a day than an index or ETF, as indices and ETFs are diversified. In short, I prefer the diversified trading vehicle because it moves slower, and I have more time to realize when my position is going the wrong way.

3) You can unwind your spread at any time (whether or not it's working in your favor). You don't have to (and absolutely shouldn't) let the spread expire even if it's only worth 5 cents.

If it's that cheap, then it's even more of a reason to get out, as you can only profit by another 5 cents, but you could still lose your maximum risk. Try to always be out of options positions at least 10 calendar days before expiration.

Chris Rowe is the Chief Investment Officer for Tycoon Publishing's The Trend Rider. To learn more about him, click here to read his bio.

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