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Investment Options

Best IRA, Mutual Funds, Stocks, Currency, Forex, Gold, Silver & other Commodity Trading Investment Strategies for 2014

A bull put spread involves being short a put option and long another put option for same expiration but with a lower strike. The short put generates income, whereas the long put's main purpose is to offset assignment risk. Because of the relationship between the two strike prices, the investor will always be paid a premium (credit) when initiating this position.

This strategy entails precisely limited risk and reward potential. The most this spread can earn is the net premium received at the outset, which is likeliest if the stock price stays steady or rises.

If the forecast is wrong and the stock declines instead, the strategy leaves the investor with either a lower profit or a loss. The maximum loss is capped by the long put.

Outlook

Looking for a steady or rising stock price during the term of the of options.

While the longer-term outlook is secondary, there is an argument for considering another alternative if the investor is bearish on the stock's future. It would take careful pinpointing to forecast when an expected rally would end and the eventual decline would start.

Summary

A bull put spread is a limited-risk-limited-reward strategy, consisting of a short put option and a long put option with a lower strike. This spread generally profits if the stock price holds steady or rises.

Motivation

Investors do this spread either as a way to earn income with limited risk, or to profit from a rise in the underlying stock's price, or both.

Max Loss

The maximum loss is limited. The worst that can happen is for the stock price to be below the lower strike at expiration. In that case, the investor will be assigned on the short put, now deep-in-the-money, and will exercise the long put. The simultaneous exercise and assignment will mean buying the stock at the higher strike and selling it at the lower strike. The maximum loss is the difference between the strikes, less the credit received when putting on the position.

Max Gain

The maximum gain is limited. The best that can happen is for the stock to be above the higher strike price at expiration. In that case both put options expire worthless, and the investor pockets the credit received when putting on the position.

Profit/Loss

Both the potential profit and loss for this strategy are very limited and very well-defined. The initial net credit is the most the investor can hope to make with the strategy. Profits at expiration start to erode if the stock is below the higher (short put) strike, and losses reach their maximum if the stock falls to, or beyond, the lower (long put) strike. Below the lower strike price, profits from exercising the long put completely offset further losses on the short put.

The way in which the investor selects the two strike prices determines the maximum income potential and maximum risk. By selecting a higher short put strike and/or a lower long put strike, the investor can increase the initial net premium income.

Breakeven

This strategy breaks even if, at expiration, the stock price is below the upper strike (short put strike) by the amount of the initial credit received. In that case the long put would expire worthless, and the short put's intrinsic value would equal the net credit.

Breakeven = short put strike - net credit received

Volatility

Slight, all other things being equal. Since the strategy involves being short one put and long another with the same expiration, the effects of volatility shifts on the two contracts may offset each other to a large degree.

Note, however, that the stock price can move in such a way that a volatility change would affect one price more than the other.

It is possible that the user may assign different volatilities to each of the strikes if they choose to solve for them.

Time Decay

The passage of time helps the position, though not quite as much as it does a plain short put position. Since the strategy involves being short one put and long another with the same expiration, the effects of time decay on the two contracts may offset each other to a large degree.

Regardless of the theoretical impact of time erosion on the two contracts, it makes sense to think the passage of time would be a positive. This strategy generates net up-front premium income, which represents the most the investor can make on the strategy. If there are to be any claims against it, they must be occur by expiration. As expiration nears, so does the date after which the investor is free of those obligations.

Assignment Risk

Yes. Early assignment, while possible at any time, generally occurs only when a put option goes deep into-the-money. Be warned, however, that using the long put to cover the short put assignment will require financing a long stock position for one business day.

And be aware, any situation where a stock is involved in a restructuring or capitalization event, such as for example a merger, takeover, spin-off or special dividend, could completely upset typical expectations regarding early exercise of options on the stock.

Expiration Risk

Yes. If held into expiration this strategy entails added risk. The investor cannot know for sure whether or not they will be assigned on the short put until the Monday after expiration. The problem is most acute if the stock is trading just below, at, or just above the short put strike.

Say, the short put ends up slightly in-the-money, and the investor sells the stock short in anticipation of being assigned. If assignment fails to occur, the investor won't discover the unintended net short stock position until the following Monday, and is subject to an adverse rise in the stock over the weekend.

There is risk guessing wrong in the other direction, too. This time, assume the investor bets against being assigned. Come Monday, if assignment occurs after all, the investor has a net long position in a stock that may have lost value over the weekend.

Two ways to prepare: close the spread out early, or be prepared for either outcome on Monday. Either way, it's important to monitor the stock, especially over the last day of trading.

Read full detail and check out the Position Simulator at OptionsEducation.org

Do you ever wonder how the Options work and does it all sound greek to you when other people are talking about Calls and Puts? First of all, Options are very risky investment and are not suitable for everyone. Options could lose significant value in a very short period of time. Now for everything, you have to learn and begin somewhere. But it is good to understand that Options are high risk - high return type of investment.

When you buy Options, it gives you right to buy/sell the underlying stocks. When you sell options, you have obligation to buy/sell the underlying stocks. There are two types of options, Calls and Puts. Call Options give you right to buy underlying stocks when you buy it. For seller, it creates an obligation to sell the underlying stocks if the buyer wants to exercise his right. When you buy Put Options, it gives you right to sell the underlying stocks and similarly the seller has obligation to buy the underlying stocks if the buyer wants to exercise his right.

Now above definitions are confusing enough for someone trying to understand the basics. So let's dive into the detail. Why would someone want to buy Call Options or Put Options? Options are the most innovative investment instrument ever invented. If you look at the stock prices today, there are majority of good stocks which a normal individual investor can't reasonably afford. The Options allow the investor chance to invest in these stocks at lower prices and many times at fraction of what the stock price is. So if you think a particular stock is currently trading at an attractive price and it would go higher in future, you can explore the possibility of buying Call Options for that stock. Similarly, if you think a particular stock is trading at higher price and it would go lower in future, buying the Put Options for that stock should be explored. The cost of the Options is called Premium. So the next question arises, why would someone want to sell the Call Options or Put Options? Short answer, to earn the premium. If you hold some stocks and you think the stock prices for the defined timeframe would remain same, you can explore the possibility of selling the Call Options for little higher price than the current price and collect the premium. This would be called Covered Call since you already own the stocks and would be able to sell it if the buyer later wants to exercise his right to buy the stocks. If you didn't own the stock while selling the Call Options, it would be called Naked Call, this would be the riskiest of Options. Now if you want to buy some stocks at lower price than it is currently trading but don't think it would go down that much in defined timeframe. you can explore the possibility of selling the Put Options at the lower Price and collect the premium. If the stock eventually goes down to that price within that timeframe, you would simply buy the stocks. These are the simplest definitions and explanation.

Let's take some examples to make this clear and understand some more terms associated with Options. Let's consider Microsoft (MSFT) stock which currently traded at $27.12 on September 16th, 2011 at the close. Now we'll cover some hypothetical examples. You should do proper research and analysis before deciding a stock price would go higher or lower. Let's consider that you are bullish and think the price would go significantly higher by January 2012. You could look at the Calls prices and can purchase $29 Call for about $0.87 per share. One contract option include 100 shares so it would cost you $87. Here the $29 would be called Strike Price and $0.87 is Premium. January 2012 Contract expires on January 21, 2012. The premium for any Options get determined from four main factors; Current Stock Price, Strike Price, Days to Expiration and Implied Volatility. The Options which expire further out would be more expensive because of the time value associated. Also, the stocks with higher implied volatility would cost more. Now for the example we are talking, before January 21, 2012, if and when the Microsoft stock trades above $29.00, the Option would be called 'In the Money'. If you are bearish about Microsoft stock and think that it would go significantly lower by January 2012, you could consider buying the Put Options of MSFT and can purchase $24 Put for about $0.85 per share. If by January 21, 2012, the Microsoft stock trades below $24, the Option would be 'In the Money'.

I would recommend setting an exit strategy on Options trades as the value changes very rapidly and you could either lose a lot of money or could miss on the profits.

Disclosure: I have no positions in any stocks mentioned, and do not intend to initiate any position within the next 72 hours.

Earlier today, US Government sued and filed an Antitrust complaint to block the AT&T takeover deal of T-Mobile. There are four major wireless carriers currently in US. Verizon (VZ) enjoying the top spot, AT&T (T) the second largest followed by Sprint Nextel (S) at third and T-Mobile (DTE) at fourth spot.

“AT&T’s elimination of T-Mobile as an independent, low- priced rival would remove a significant competitive force from the market,” the U.S. said in its filing. The merger would make AT&T no. 1 US Carrier ahead of Verizon. Now there are some cancellation fees associated if the deal doesn't go through. AT&T would have to pay Deutsche Telekom (DTE) $3 billion in cash. It would also need to provide T-Mobile with wireless spectrum in some regions and reduced charges for calls into AT&T’s network, making a total package valued at as much as $7 billion, according to Deutsche Telekom earlier this month.

No wonder AT&T shares are falling more than 4%, down to 28.28 (-4.52%) as of this writing. The associated cancellation fees give AT&T the incentive to fight the suit and make their case in favor of the deal. The FCC has not made any decision in favor or against the deal. This whole scenario makes the situation a big mess.

The bright side is AT&T's current dividend yield of more than 6%. In the worst case scenario, AT&T still remains a no. 2 Carrier, needs to pay up to $7 Billions in charges for cancellation. AT&T still needs to improve their coverage but in GSM technology based network they are still going to be the leader. There is going to be a new iPhone coming soon, definitely for AT&T network.

I would recommend that the half-and-half strategy be applied to AT&T (T). The half-and-half balances the potential reward of buying stocks with the risk of buying while the stock trend is uncertain. If you want to own 200 shares of a stock, buy 100 shares and sell one put. If the stock is put to you, you'll buy more shares, but at a lower price. As a bonus, you will have earned the premium on the put sale. The risk would be if the stock races higher and you miss the gains from the additional shares not bought. But then you would have gains in the stock you already bought.

The investor would buy 100 shares of AT&T (T) at $28.00 and sell one January $26.00 put for $1.30ish. If the stock is put to that investor because it falls below $26, the investor will buy an additional 100 shares at $24.70. This effectively lowers the average price of the 200 shares to $26.35 each.