Stock Option Trading Strategies Debit Spread
.One of my favorite stock option trading strategies is the Debit Spread. This is when you buy a Call option on a stock and then sell a Call option (at a higher strike price) on the same stock.
I like to use this option trading strategy whenever I have bought a Call option and have considerable profit. It allows me to take my money out of the investment but still generate extra profit for free!
Here is a real example of how I make free money using option strategies called a Debit Spread:
On April 4, 2008 I bought a Call option (CLFJJ) on CLF. The contract cost me 20.30 for a total of $2,030.00 per contract. Two weeks later on April 14, 2008 the contract had risen to a value of 27.35 for a gain of 34.7% in only two weeks.
At this time most investors will either hold or sell. I felt the market wasn’t too stable, and since I’m not a greedy person a 34.7% gain in two weeks was good for me.
Now here is where a Debit Spread can be advantageous. I could take my money out and still keep my contract and make more money! The first thing you need to do is look for a Call option that is at a higher strike price than the one you already have. For example CLFJJ had a strike price of 100.00.
So I started looking for a Call option I could sell that would net me about $20.00 (the price I paid for CLFJJ). Now remember, this new Call option must also have a higher strike price than the original one. The option I found was CGJJM. This option had a 130 strike price, definitely higher than CLFJJ’s strike price of 100. I could also sell it for $19.95 and get most of my money from CLFJJ back.
After this trade my results were this: I paid $2,030 for CLFJJ. After two weeks I got back $1,9995 by selling CGJJM for $1,995. My total investment now after two weeks is only $35 per contract! Basically what I am doing is just leaving in $35.00 of my principal and the $705.00 of profit I made the past two weeks.
Now with my money back in my pocket I can do more option trading. The $35 principal + $705 profit, is left to grow some more. The Debit Spread is one of many options strategies.
UPDATE: The final tally (I closed these positions on September 10, 2008) on this was a profit of $1,215 per contract versus the $705 proft per contract had I just sold the call originally instead of doing the spread. It took five months longer but made an extra $510 on my $35 out of pocket expense. Remember these numbers are per contract.
BTW, the final numbers on the two contracts were as follows. I eventually closed CLFJJ at $22.50, which is $4.85 LESS than the price it was on April 14th ($27.35). But the reason I was still able to make a bigger profit is because the the call I sold, CGJJM. Remember, I sold it for $19.95 but when I closed it, I only had to pay back $10.00. This one went down at a greater rate than CLFJJ, hence the extra profit. The math is.. I had to pay $1,000 per contract to close CGJJM and I got back $2,250 per contract when I sold CLFJJ, thus equaling the profit of $1,250.