Leverage Your Options Investments

Leverage Your Options Investments
by Ken Trester 08/26/08

BUY HIGHER-QUALITY TRADES FOR THE SAME PRICE AS (OR LESS THAN) THE LONG SHOTS

A way to play higher-priced options yet still only pay a nominal amount to enter the trade is through a bull-call spread, which involves the purchasing of an at-the-money or in-the-money call option and then writing (i.e., selling to open) an out-of-the-money call option at a higher strike price.

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And if you're a little nervous about holding options short in your trading account, don't worry -- you're covered by those long calls and you likely won't have to touch a single share of stock because you're in a spread trade and not truly "naked" (naked meaning not "covered" with long stock or a long call). The long call in this instance serves as a surrogate for the stock and provides equal protection in case the trade turns against you.

A bull-call spread is what's known as a debit spread -- meaning, you're paying to enter the trade, but it's significantly less than only buying the long call options in this spread, because you're also taking in some premium by selling calls in this simultaneous transaction.

For instance, you can buy a July $40 Call for $2.50 and sell a July $45 Call for $1, which means your net debit will be $1.50.

In this example, you've "earned" $1 in premium upfront and have upped your odds in "winning" with your trade, as the spread concept provides a bit of a safety net and gives you more leverage in the markets.

The bull-call spread is just one of many strategies you can use to play the options markets, but if you have a positive outlook on the stock and also want to limit your downside as well as the amount of your investment, spread trading is a powerful tool to have in your arsenal. The caveat is that your profit potential gets capped, but while you might not "win big," you also won't "lose big" either.

Keep in mind that with any options trade, the most you can lose is as much as you put into it. And while we're all playing to win, the losers hurt a lot less when there's not very far to fall.