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Last post 05-10-2008, 1:37 PM by SeanK. 2 replies.
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  •  05-08-2008, 12:27 PM 28730

    Position Management of Vertical Bull Spreads

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    I'm looking for opinions of how people like to manage their bull vertical spreads. Specifically does anyone have an opinion of the strategy where one buys a bull call spread 1 strike wide and as the stock moves up and past the short strike, buying the short back and selling the next higher strike.  
    Example: 
    Stock is at $98
    Buy the Sept 100 call
    Sell the Sept 105 call
    When the stock reaches or passes $105, buy back the 105 call and sell the 110 call.

    The affect of doing this as I see it is two fold.  One, you are increasing your position and thus if you continue to be right about the stock you make more $$.  And two, if in the short term the stock pulls back below $105, you have the option of buying back the 110 call and selling the 105 call again.  This allows one to collect some premium during pull backs. 

    I understand this works only if the stock is moving up in a nice orderly fashion.  I also understand your risk increases somewhat from the initial position because the spread is wider.

    Thoughts?

    -Sean
  •  05-09-2008, 12:00 PM 28805 in reply to 28730

    Re: Position Management of Vertical Bull Spreads

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    When learning option strategies there is a tendency to view the strategy as the engine which drives the profits or losses rather than the correctness of one's ability to predict price movements.  This is likely due to the fact that it takes time to grasp the nuances of the strategies and we focus on what we have spent our time learning.

    In this case we are looking at the following idea:  Buy the 100-105 call spread.  If the price moves up to 105 then buy the 105-110 call spread, leaving us long the 100-110 call spread.  You seem to have a grasp of what the new position offers.  That is, the potential to reap the 10 point spread between 100 and 110 instead of the 5 point spread between 100 and 105, less the cost of putting the trade on.

    But doesn't the question really hinge more on your expectations for the price movement of the stock?  To enhance your knowledge you may want to run some numbers on different possible outcomes over time, given those expectations.  Then I would recommend learning more about the impact of implied volatility changes with particular emphasis on vol skews and how they impact the position and what they reveal about market expectations.

    Bear in mind that the more options you trade the more transaction costs you must overcome in order to be profitable.  Commissions and spreads add up.

    Finally, another simpler and different approach, depending again on your expectations, is to buy the 105 call.  Should the price move to 105 then sell the 105-110 call spread leaving you long the 110 call.  At that point you will have little to lose and retain the potential for further gains if the upward price movement continues.  Just a thought.

  •  05-10-2008, 1:37 PM 28863 in reply to 28805

    Re: Position Management of Vertical Bull Spreads

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    Wow!  Thank you for taking the time to write up a detailed reply.  You confirmed most of what I was thinking about this type of trade.   I agree with you  on the commisions - you have to pay attention to what those are costing you.   I generally keep the number of sell/buys on the shorts low so as to not create too many commisions.  Good point on the volitility affecting the trade.  It is something I keep an eye on for sure.

    I will add to the discussion that this strategy has worked much more effectively in the current market conditions.  Prior to the credit crisis last fall it wasn't something I used much because the stocks I was bullish on traded in a consistant up trend. 

    I like this trade for stocks I am very bullish on and I know the market may smack them down occasionally for no good reason.  Usually they get lumped in with other stocks that aren't so good and the market pulls the whole sector down at one time.   If that happens, I can collect a little premium if it falls far enough. 

    Thanks again for the reply.  I am always looking for other trader's opinions on different strategies. 



    -Sean
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