Growing Wealth Archives | Page 138 of 224

Feb

2023

Guide to Moneyness in Options

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

When you’re talking about moneyness in options, certain phrases capture where the strike price is in relation to the current price of the underlying asset.

Options are either in-the-money (ITM), out-of-the-money (OTM), at-the-money (ATM), or near-the-money. You can also have options that are deep-in-the-money or far-out-of-the-money.

Generally, a call option is in-the-money when the strike price is below the underlying asset price while a put is ITM when the strike price is above the underlying asset price. You flip the relationship for out-of-the-money options: an OTM call’s strike price is above the underlying stock price while an OTM put’s strike price is below the stock price.

What Is Moneyness?

The moneyness of an option describes the relationship between the strike price of an options contract and the price of the underlying shares. To explain the strike price: it refers to the price at which an investor can buy or sell a derivative contract.

Option moneyness can change depending on how the stock price moves. For example, a call option can be out-of-the-money one day, but then a share price appreciation can result in that same call turning in-the-money the next day.

Moneyness may also change on a minute-by-minute basis depending on the price fluctuations in the underlying stock.

Moneyness of options can be used to construct your options trading strategy — e.g. going long or short options, purchasing puts or calls, and executing more sophisticated options strategies.

Recommended: How to Trade Stock Options

How Does Moneyness Work?

Understanding the moneyness of an option is important for different core options trading strategies. As explained earlier, moneyness works by comparing the strike price of an option to the market price of the underlying shares.

Because options are complex, it’s also important to know options terminology.

• An in-the-money (ITM) option has intrinsic value and time value.

• An out-of-the-money (OTM) option only has time value, and thus is worthless if exercised.

• OTM options have zero intrinsic value and thus are cheaper than in-the-money options.

• At-the-money (ATM) options are rare since it might only occur for a moment when the stock price equals a specific strike price — near-the-money options are more common.

• A near-the-money option has a strike closest to the underlying share price on an options chain.

Practically speaking, if you are very bullish on a stock, you might consider purchasing out-of-the-money call options since those would appreciate the most on a percentage basis if there is a sharp share price rise. They also drop the most if the price moves against you.

If you expect just a small move on a stock, in-the-money options are probably the better play. And due to the leverage in options ITM will provide higher returns/losses than available by purchasing the underlying stock.

The deeper in-the-money an option is, the greater the sensitivity it will have to movements in the underlying shares.

Understanding Intrinsic and Time Value of Options

What’s the difference between intrinsic value and time value? It’s important to understand how these two factors play into the value of options.

The intrinsic value of an in-the money call option is simply the price of the stock less the strike price of the option. The intrinsic value of an in-the money put is the strike price of the option less the price of the stock.

The difference between the intrinsic value and the actual current price of the option is time value. Options that are in the money always have intrinsic value. Out-of-the-money options have no intrinsic value, but they might have time value.

The drivers of time value are complex and include many factors. If you’re looking for more information, you should consider learning about the option Greeks to inform your trading strategy.

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Types of Moneyness

An option can be categorized in four common ways with respect to the relationship with its strike price and underlying share price: in-the-money, out-of-the-money, at-the-money, and near-the-money. Understanding how option pricing works between in-the-money vs. out-of-the-money options is important.

In-the-Money (ITM)

In-the-money options are those that have intrinsic value. For a call option, that means the underlying stock price is above the option’s strike price. A put option is in-the-money when the stock price is below the strike price.

If a call option is in-the-money, you can exercise the option, receive shares at the strike price, then immediately sell the shares in the market. In-the-money puts allow the option holder to sell a stock at a higher price compared to the market price of the security. Long calls are usually used to place bullish bets on a stock while long puts are generally used when a trader is bearish.

In-the-money options, while having intrinsic value, also have a degree of time value. It is often advantageous for an options trader to exit the trade in the market rather than exercising immediately.

Options that can be exercised at any time before expiration are known as American Style options. Options that can only be exercised upon expiration are European Style. There are other differences between American and European options but the different exercise options are most relevant to this discussion.

Out-of-the-Money (OTM)

An out-of-the-money call option is one in which the strike price is above the underlying stock price. The owner of a call option hopes that the share price rises prior to expiration so that the option has intrinsic value. The seller of a call option benefits when the underlying stock price remains below the exercise price so they can keep the premium they collected when they sold to open the call.

Puts are out-of-the-money when the strike price is below the market price of the underlying shares. The owner of puts is bearish on the stock, so they want the stock to fall below the strike price so that the puts become in-the-money. Put sellers, who are neutral to bullish on the stock, hope the share price stays above the exercise price.

Out-of-the-money options do not have intrinsic value. Their premium is made up of time value only. Out-of-the-money options generally have lower premiums than in-the-money and at-the-money options since they are more likely to expire worthless.

At-the-Money (ATM)

At-the-money puts and calls have strike prices that are the same as the market price of the underlying stock. These options, like out-of-the-money options, have no intrinsic value. At-the-money options are usually more expensive than out-of-the-money options, but less expensive than in-the-money options.

This type of option moneyness means that calls and puts are heavily influenced by volatility and time decay.

Near-the-Money

Near-the-money options have strike prices that are very close to the market price of the underlying stock, so they are just slightly in-the-money or out-of-the-money.

Near-the-money options are much more common than at-the-money options since the stock price is rarely precisely at a specific strike price. Near-the-money strikes are used when a trader wants exposure to an at-the-money option that is not available in the market.

Other Moneyness Terms

Other terms for moneyness include deep-in-the-money and far-out-of-the-money. These terms have no real qualitative difference between in-the-money and out-of-the-money, but are simply intensifiers. They are, however, in fairly common usage.

What Moneyness Means to Investors

Option moneyness tells a trader important information. The trader can use the moneyness of an option to help construct a trading thesis. For example, if you believe a stock price will drop substantially over a short time frame, you might consider purchasing an out-of-the-money put option since that option type and moneyness will appreciate greatly when the stock price drops in a big way.

Moneyness of options grows more crucial when you embark on more complex options strategies since multiple option legs have different moneyness — knowing the moneyness of the options strategy is critical to understanding your exposure.

Still, an option holder might exit an option by selling or covering in the market rather than exercising early so that they can capture the time value of an option in addition to any intrinsic value.

The Takeaway

Moneyness is used to describe where an option’s strike price is relative to the price of the underlying stock. It can help options traders gauge the amount of intrinsic value an option has and inform simple and complex options strategies.

A great way to get started is with SoFi’s options trading platform. The platform’s intuitive design makes it easy to use, whether you’d prefer to trade on the mobile app or through the web platform. You’ll also have access to educational resources to continue to help guiding you along the way.

Pay zero commission or contract fees when you start options trading with SoFi.

FAQ

How is moneyness calculated?

For a call option, moneyness is calculated by taking the underlying asset’s price and subtracting the option’s strike price. If that is a positive value, the call option is in-the-money. If it is a negative value, the call is out-of-the-money. The moneyness definition describes an option’s strike price relative to its underlying stock’s market price. The underlying asset price has to be above the strike price for a call to be in-the-money.

For a put option, the opposite is true: Moneyness is calculated by taking the underlying asset’s price and subtracting the option’s strike price. If that is a positive value, the put option is out-of-the-money. If it is a negative value, the put is in-the-money. The underlying asset price has to be below the strike price for a put to be in-the-money.

An at-the-money option is simple when the stock price and strike price are the same. Near-the-money options have strikes very close to the share price.

How are moneyness and delta different?

Option moneyness simply describes the price difference between a strike price and the price of the underlying asset. Delta, on the other hand, tells a trader how sensitive an option is to changes in the underlying stock.

How are moneyness and implied volatility related?

Implied volatility tends to be lowest with at-the-money options. It increases when the option moves further out-of-the-money or further in-the-money. The “volatility smile” describes the relationship between the moneyness of an option and the implied volatility.

Photo credit: iStock/AsiaVision

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN0122055

Feb

2023

Introduction to Options Volume and Open Interest

By Brian O'Connell | Growing Wealth, invest, Investing, Terminology | Comments Off

In the world of options trading, the investor is given constant information about what is happening in the options market. Two of those pieces of information are Options Volume and Open Interest.

Options Volume represents all of the transactions made during a trading session updated in real-time.

Open Interest represents the number of open contracts at the start of each trading session and is updated once per day prior to the market opening.

How Is Option Volume Calculated?

Option Volume is different from stock volume in some fundamental ways. When you’re investing in stocks, volume represents shares trading hands. Typically trading volumes in stocks are far smaller in scale than the total shares available in a stock.

Options volume, on the other hand, can very often exceed the total contracts outstanding represented by Open Interest.

Options Volume is calculated in real-time after every transaction. This information is typically reported within the options chain and will be updated as frequently as your particular brokerage and account provides.

Every transaction is counted.

If you buy to open 10 calls, volume increases by 10 during the trading session.

If you then sell these calls to a second investor, volume increases by 10.

If this second investor closes these 10 calls, volume increases by 10.

Recommended: Popular Options Trading Terminology

How Is Open Interest Calculated?

Open Interest is calculated the same way for options trading as it is for futures trading. This information is also reported within the options chain, however it is updated once daily prior to the market opening and will not change over the course of a trading session.

Open interest represents all contracts that remain open and nets out trades from the previous session that offset.

Therefore using the same trades from above:

If you buy to open 10 calls, open interest does not change during the trading session.

If you then sell these calls to a second investor, open interest does not change.

If this second investor then closes these 10 calls, open interest does not change.

However, at the end of the session the Options Clearing Corporation (OCC) nets out any offsetting trades and reports simply the remaining open contracts.

In this example, since the options were opened and closed on the same day, and despite having changed hands, the net effect on Open Interest is zero.

What Do Option Volume and Open Interest Indicate About Options?

As far as assessing what these two data points indicate, it depends on whether you consider yourself a “fundamental” trader or a “technical” trader.

• Traders who use fundamental analysis believe in analyzing company and market data to determine what is happening in the markets. They look at corporate metrics such as profits, operating margins, debt ratios, etc, as well as some limited market data.

• Technical traders primarily focus on market data and use it to predict market sentiment and price movements.

Fundamental Analysis

Fundamental traders look at the Open Interest as an indicator of liquidity in the market. And if you dig into the typical options chain, you’ll see that higher Open Interest corresponds to lower bid-ask spreads.

These two factors taken together, result in more rapid order filling and increase the likelihood of better, i.e., more competitive, pricing.

The fundamental trader looks at Options Volume as a first indication of cash flows in and out of the option. However, these cash flows won’t be confirmed until the end of the day when a comparison between Open Interest changes from the previous day will confirm this analysis.

Increasing Open Interest shows cash moving into that option.

Recommended: What Are Calls vs Puts?

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Technical Analysis

Technical traders also look at Open Interest and Options Volume as indicators of liquidity and cash flows, but their analysis doesn’t stop there.

Technical traders look at these increased cash flows and liquidity improvements and believe that the strength in the Options Volume and Open Interest indicate confirmation of the trends occurring in the price of the underlying asset.

For example, if the underlying asset is seeing price increases and call volumes and Open Interest are also increasing, then the technical trader sees confirmation of the trend and these factors reinforce the likelihood of the trend continuing.

Conversely, if the Options Volume and Open Interest are changing at a slower pace, this may indicate that the previously existing trends in the underlying market – whether up or down – may be coming to an end.

Technical Analysis, Other

Although the following phenomenon falls under technical trading, it should really be its own brand of trading.

Often, you’ll hear experienced options traders talking about spikes in Option Volume and Open Interest as an indication of what the “smart money” is doing, or that “somebody knows something” about a particular company or a particular trade.

Consider this a red flag. First, just because an investor has made a large investment, doesn’t make them “smart.”

Second, why have they made that investment? Is it a single position, or one of a few different types of investments, or a combination trade that you may not know about, and with different investment goals than what you are pursuing.

Finally, the people who made the trades, and those who identify these spikes, typically have access to information and resources the typical investor does not have access to. That means while they might be going into a trade with eyes open, you may not have the same visibility.

Option Volume	Open Interest
Total of all transactions during a trading session	Total of all open contracts at the start of a trading session
Updated continuously after every transaction	Updated once per day prior to the trading session
Opening a transaction increases the volume	Opening a transaction will increase Open Interest
Closing a transaction increases the volume	Closing a transaction will decrease Open Interest
Indication of liquidity	Indication of liquidity
Indication of Cash Flows	Confirmation of Cash Flows

The Takeaway

Options Volume and Open Interest can be useful data points for the options investor.

Depending on your particular investing approach, fundamental versus technical, you may use this information in varying ways to inform your investing decisions.

If you’re ready to try your hand at options trading, You can set up an Active Invest account and trade trade options online from the SoFi mobile app or through the web platform.

And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commission, and members have access to complimentary financial advice from a professional.

With SoFi, user-friendly options trading is finally here.

Photo credit: iStock/BartekSzewczyk

Feb

2023

Leap Options: What Are They? Pros & Cons

By Samuel Becker | Growing Wealth, invest, Terminology | Comments Off

The term “LEAPS” in LEAPS options is actually an acronym, which stands for “Long-term Equity Anticipation Securities.” LEAPS options are long-term options that have an expiration period between one and three years, versus less than a year for standard options.

LEAPS (sometimes called leap options) are derivatives contracts traded on exchanges, and allow investors to utilize less capital than if they were purchasing the underlying asset outright.

Other than the longer-than-normal expiration date, leap options are functionally much like other types of options — they’re contracts that grant the buyer the right to buy or sell an underlying asset at a specific price before its expiration date.

LEAPS Options Defined

Puts, calls, bulls, and bears. For the uninitiated, options terminology offers a steep learning curve. Even those who are familiar with options trading can occasionally find themselves in the weeds, as there are myriad option types and derivatives to keep track of.

LEAPS or leap options are a variation on the basic options contract, and these longer-term instruments may become part of your strategies for trading options.

LEAPS come in two basic flavors: call options and put options. And like shorter-term options, traders pay a premium when buying LEAPS options. Further, LEAPS can be tied to individual stocks or ETFs, as well as market indexes and other types of securities.

Recommended: Options Trading 101

How to Buy LEAPS Options?

Buying LEAPS options is pretty straightforward, assuming you’ve been investing for a bit. Typically, all that’s required is a brokerage account with access to options trading — and that’s something that many, if not most brokerages offer investors.

The process for actually executing a LEAPS option trade will depend on the specific brokerage you use, but it’ll generally involve choosing a put or call option, a strike price, and critically, a long-term expiration date.

Remember, LEAPS options expire more than a year from when they’re purchased, so opting for the longer-term expiration date will differentiate a LEAPS option from a standard option purchase. This may be helpful when considering long-term vs. short-term strategies.

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

What Are the Pros & Cons of LEAPS Options?

Like trading other types of options, there are some upsides and downsides to trading and investing with LEAPS options:

What Are the Pros of LEAPS Options?

A big upside to LEAPS is that they have a longer time frame compared to standard options. Thus, they experience less time decay, and theoretically, their values should move more closely with the price movements of the underlying asset.

A less recognized advantage of the longer time frame is that — unlike options that may expire in months, weeks, or even days — the need to constantly oversee the markets and to take advantage of short-term moves is lessened.

LEAPS also tend to cost less than their underlying asset, making them an attractive alternative for some investors.

But perhaps the biggest advantage to LEAPS is they can provide outsized returns, despite the attendant risks, which is what attracts some traders to them in the first place.

What Are the Cons of LEAPS Options?

On the other side of the coin, investors should know that LEAPS can have higher premiums than standard options due to the much higher time value of LEAPS while still remaining cheaper than the underlying asset.

Buying LEAPS, you’ll need to put more money upfront than if you were to purchase shorter term options, risking more of your capital.

LEAPS are also not available for every stock, industry, or index out there (index investing is a separate strategy, but some options are tied to indexes). So, you may not be able to find what you want.

Plus, if you decide to purchase LEAPS options, you could also magnify your losses (just as you can increase your gains), which is something that’s critical to keep in mind. In other words, there are additional risks when investing with LEAPS.

LEAPS Options: Pros and Cons
Pros	Cons
Potentially magnify investing gains	Potentially increase investing losses
Costs less than the underlying asset	Higher premiums vs. standard options
Value mirrors underlying asset more closely	LEAPS may not be available for all assets

Explaining LEAPS Options Trading

How does LEAPS options trading actually work?

Let’s run through an example, and note that trading LEAPS is the same as trading options, but with longer expiration periods:

If you were of the belief that a certain stock, we’ll call it Stock XYZ, was going to experience a decline in value at some point in the next few years, you could use LEAPS options to position yourself accordingly. Specifically, you’d look at buying a LEAPS put option on XYZ with a long-term expiration date.

XYZ is trading at around $55, but again, you think that it will fall. As such, you pay $7.50 for a $45 put that matures more than a year from now.

If XYZ drops in price, you can expect the put to increase in value and you may sell for a profit as you see fit.

You can wait for the XYZ to drop below $37.50 (your break even point = $45 – $7.50 = $37.50) and exercise your option or sell the option. Based on time to expiration and multiple other factors, you can decide which choice is more profitable.

Recommended: Long-term Investing Strategies

What Are Some Helpful LEAPS Options Strategies?

There are many different strategies for trading options, and many can be applied to trading LEAPS. And since options strategies can quickly get complicated, it may be best to keep it simple.

As such, one basic LEAPS options trading strategy is to buy calls, and try to benefit from a potential increase in value of the underlying asset over the course of a year or two.

LEAPS can almost stand in for the underlying asset itself, and offer a couple of key advantages: They can increase returns by allowing you control over more shares for less capital, and minimizing your potential losses to the cost of the option’s premium.

Active investors can use LEAPS to benefit from short and long-term market activity. If, for instance, you thought that XYZ was going to experience a stock value decline over the next year, but suspect that it may bounce back and increase in value over two or three years’ time.

You could buy a three-year put LEAPS call option, in that case, along with a standard put option. That would allow you to potentially benefit in the short and long-term in regards to Stock X.

Invest in LEAPS Options with SoFi

The chief difference between LEAPS options and other types of options is that they have longer-than-normal expiration periods of one to three years versus less than a year for traditional options.

Other than that, LEAPS are similar to other types of options in that they’re derivative contracts that grant the buyer the right to buy (call options) or sell (put options) an underlying asset at a specific price before its expiration date.

Trading options is complicated, and can be quite risky, there’s no way around it. For some investors, it may be best to stick to the basics — invest for the long term, and build a portfolio with stocks and ETFs. But once your bases are covered, options can be a next step in your investing evolution.

If you’re ready to try your hand at online options trading, SoFi can help. You can trade options from the SoFi mobile app or through the web platform. And if you have any questions, SoFi offers educational resources about options to learn more.

With SoFi, user-friendly options trading is finally here.

Photo credit: iStock/dusanpetkovic

Feb

2023

Strategic Overview: What Is a Cash-Secured Put?

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

A cash-secured put is an income options strategy in which an investor sells a put option on a stock while setting aside the cash to buy that stock, in case the stock price drops below the strike price of the put option and is assigned to the investor.

This strategy is useful for investors who believe a stock may drop in price over the short term and then increase long term. It allows the investor to generate income on the sale of the put, set the price (strike price) at which they will buy the stock if assigned, and enter a stock position at a lower price than when the trade is initiated.

The Details of Selling a Cash-Secured Put

Put options and call options are a type of derivative that may allow investors to gain — not by owning the underlying asset and waiting for it to go up, but by strategically using options contracts to profit from the asset’s price movements.

Similar to the strategy of shorting stocks, the way investors use options reflects their view on whether the price is likely to go up or down.

Selling cash-secured puts is a bullish options trading strategy that involves selling a put option with the hope that it either expires, or the underlying security temporarily drops in price and lets the investor purchase the security at the lower price.

Selling a put obliges an investor to purchase a certain number of stock or ETF shares at a specific price (the strike price) by a specific future date (the expiration date). Investors will choose a put that is out-of-the-money, i.e., with a lower strike price than the current stock price.

What to Consider With Cash-Secured Puts

Investors earn a premium immediately when they sell the cash-secured put. This is a strategy where investors generally sell cash-secured puts associated with securities they don’t own, that they expect to decrease in value in the near future but increase over the long term.

The contract may also require the investor to purchase the security prior to the exercise date if the price of the security drops to lower than the strike price. If the market price of the security is lower than the strike price at the exercise date, the investor still has to purchase the security at the strike price.

If the market price of the security is higher than the strike price at the exercise date, the investor is not obligated to purchase the security and the put expires. In this case, the investor has earned the premium amount and profited from the trade, as they say in options terminology.

Investors are required to have enough cash in their trading account to cover the full purchase amount. The investor must maintain that cash amount in their brokerage account for the duration of time they hold the put, which is why it’s called a cash-secured put.

Recommended: The Meaning of a Bullish Market

Some investors in puts don’t ever plan to purchase the underlying security, they simply want to profit off of the options premium. In that case they would generally write a naked put, which doesn’t require them to hold the cash to purchase the security.

The investor would hope that the put expires without obligating them to buy, and they could pocket the premium amount. Cash-secured puts are geared towards investors who actually want to purchase the underlying security on or before the exercise date at a price of their choosing.

There are some benefits to selling cash-secured puts, and they can be profitable, but investors should understand the risks before trying this investment strategy.

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Pros & Cons of Cash-Secured Puts

Options strategies require the investor to be aware of multiple issues and cash-secured puts are no different.

What Are the Pros of Cash-Secured Puts?

• The investor earns the premium amount regardless of whether they end up purchasing the security.

• If the stock price decreases below the strike price, the investor can purchase the security at the strike price of the put which will be lower than the stock price when the trade was initiated.

Note that if the stock price drops below the strike price and the shares are assigned, the investor will still pay the strike price for the shares. Be sure to think about what determines the stock price of the underlying.

• If the price ends up increasing instead of decreasing, the put will expire worthless and the investor keeps the premium and the cash set aside for the stock purchase.

• If an investor thinks a security is going to decrease in value in the short term but increase over the long term, cash-secured puts are a way they can purchase the security at a price less than the current market value.

• Maximum gains from the put option have a limit, but potential long-term gains after the put option is exercised are unlimited.

What Are the Cons of Cash-Secured Puts?

• The security might drop below the strike price, it could even fall to $0. It might seem unlikely that a large corporation would go bankrupt, but it has happened before and can happen again.

In this case the investor would still be obligated to purchase the security at the higher strike price, and would then hold a worthless security. However, even if the security plummets, the investor would still earn the premium amount, and their losses would be less than if they’d simply purchased the security instead of selling the put option.

• When entering the trade the investor must be prepared to accept the strike price no matter what happens in the market before the exercise date.

◦ Maximum loss = strike price x 100, minus the premium amount

◦ Maximum gain = premium amount

• A cash-secured put allows the investor to wait for a dip in the security’s price. If the security ends up increasing in value without a short-term dip, the investor has missed out on the opportunity to purchase the security. The put will expire worthless and they will need to make a decision whether to buy at the new, higher price or enter a different trade.

If an investor knows they want to purchase the security they may want to consider other investing strategies or simply purchase the security at the current market price instead of using the cash-secured put strategy.

• The investor must hold enough cash to cover the cost of the security for the duration of the trade. This means they can’t invest that cash into other trades.

• From a short-term perspective, the potential losses from a cash-secured put option trade are high and the potential gains from the put option itself are low.

Tips for Employing a Cash-Secured Put Strategy

• If an investor is bullish on a security, they should choose an out-of-the-money put option with a strike price below the current market price of the stock.

• When an investor sets a strike price that is far out-of-the-money, they receive a lower premium and the option is less likely to be exercised.

• Investors who are very bullish on a security in the short term should choose other investing strategies. Cash secured-put options are best if the investor has a neutral to slightly bullish view of the security.

• It’s best to sell cash-secured put options when implied volatility of a security is high, because this results in higher option premiums. One way to find securities with high implied volatility is to look for high-quality stocks that have recently declined. The decline is likely to be somewhat temporary but the investor can get in at a lower market price with a higher premium. However, just because a company is large doesn’t mean its stock can’t continue to drop, so it’s important to do a detailed analysis before choosing any securities.

• Due to the risk of a security’s price dropping more than the investor expects in the short term, it’s best to only sell put options for companies that the investor has researched.

• Investors generally sell puts with 30-90 day time frames, but some investors choose to sell weekly put options.

Looking to Start Trading Stocks? Invest Today with SoFi

Cash-secured puts are one possible way to generate income while an investor waits for a stock to drop to their desired entry price. Selling cash-secured puts is a bullish options trading strategy that involves selling a put option with the hope that it either expires, or the underlying security temporarily drops in price and lets the investor purchase the security at the lower price.

And while this strategy is not without risk, it can allow the investor to generate short-term income on the sale of the put, set the price (strike price) at which they will buy the stock if assigned, and enter a stock position at a lower price than when the trade is initiated.

If you’re ready to try your hand at options trading, SoFi can help. When you set up an Active Invest account with SoFi, you can start investing online today. You can trade options from the SoFi mobile app or through the web platform. You can also buy and sell stocks, ETFs, and more. And if you have any questions, SoFi offers educational resources to learn more.

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Feb

2023

What Is a Call Debit Spread?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

A call debit spread — also referred to as a bull call spread or a long call spread — is an options trading strategy where a bullish trader purchases a call option at the same time as they sell another call option with a higher strike price and the same expiration date.

Essentially the call debit spread is a long call with the addition of a hedge of a short call to reduce risk. The level of risk is well defined; but it has limited profit potential.

This options strategy can be a good way to profit from increases in underlying asset prices.

Call Debit Spread Definition

Like some other common options strategies, call debit spreads may be traded out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM).

To understand this strategy it helps to review the basics of call and put options. The basic steps of the strategy are:

• Purchase a call option

• Sell a call option with a higher strike price

The reason they are called debit spreads is the trader will incur a debit (cost) equal to the price of the purchased call option less the price of the sold call option when they enter the trade. An investor loses the entirety of their debit if the underlying stock closes below the strike price of the long call (the lower strike price).

The closer the strike prices are to the price of the underlying asset, the higher the debit payment is. But a higher debit also means a higher potential profit.

Recommended: Guide to Writing Put Options

Entering and Exiting a Call Debit Spread

To enter a call debit spread, a trader purchases a buy-to-open (BTO) call option and a sell-to-open (STO) call option that has a higher strike price and the same expiration date. The way the trade is structured, the trader is paying a debit. The entry can be at any strike price.

If a trader is more bullish, they can choose to purchase a spread that is more out-of-the-money. By selling the call option with the higher strike price, the trader gets into the trade at a lower cost and defines their risk and profit level.

To exit a call debit spread, the trader sells-to-close (STC) the long call option and buys-to-close (BTC) the short call option.

Traders have some ability to adjust their trade prior to the option expiration date, but they will pay an additional amount to do so, thereby increasing their risk and lowering their profit potential.

Additional flexibility exists in the ability to roll out spreads to a later expiration date. A trader might choose to do this if the option’s underlying asset price hasn’t moved enough to make the trade profitable.

In order to do this, the trader can sell the bull call spread they own and buy a new spread that has an expiration date further in the future. This can potentially increase the potential for profit but the trader will have to pay an additional fee, so this adds some amount of risk to the trade.

This is just one of many strategies traders can consider when thinking about how to trade options today.

Call Debit Spread Examples

Let’s look at two examples.

Example 1

Stock XYZ is currently trading at $100 per share. To enter into a call debit spread, a trader could purchase a $103 call for $1.00 at the same time as they sell a $105 call for $0.40. This would create a net debit, which is why it’s called a call debit spread.

The maximum loss and net debit for this call debit spread is:

Premium paid = Cost of Long call – Cost for Short Call

Premium paid = $1.00 – $0.40 = $0.60 net debit

Note: The $0.60 net debit is per share. Since an option contract is for 100 shares, the debit will be $60 per option contract.

The maximum profit for this call debit spread is:

Maximum profit = Width of strike prices – Premium paid

Maximum profit = $105 – $103 – $0.60 = $1.40 per share or $140 per option contract

The breakeven point for this trade is when the stock price reaches:

Breakeven = Strike price of long call + Premium paid

Breakeven = $103 + $0.60 = $103.60

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Example 2

A trader buys a call option for $50 and sells a call option for $55. The trade costs them $2. This makes their maximum loss for the trade $200, which they will lose if the stock option expires at a price below $50. If the stock option closes above $55, the trader will profit $300. The trader will break even at a closing price of $52.

The maximum loss and net debit for this call debit spread is:

Premium paid = $2.00 (we don’t know the costs of each call but the total debit is given as $2.00)

The maximum profit for this call debit spread is:

Maximum profit = Width of strikes – Premium paid

Maximum profit = $55 – $50 – $2 = $3 per share or $300 per option contract

The breakeven point for this trade is when the stock price reaches:

Breakeven = Strike price of long call + Premium paid

Breakeven = $50 + $2 = $52

Maximum Gain, Loss, and Break-Even for Call Debit Spread

The maximum profit for a call debit spread is:

Width of Strikes – Premium (Debit) paid

The maximum loss for a call debit spread is:

Premium paid

The break-even point for a call debit spread is:

Premium paid + Strike price of the long call

Recommended: How to Trade a Bull Put Spread

Why Trade Call Debit Spreads?

Traders choose to use the call debit spread option strategy when they are bullish on the underlying stock or asset.

Traders will also use the call debit spread strategy if they want to take a long position on an asset without actually spending all the money required to buy the asset itself. This gives them exposure to the asset with less risk and lower capital requirements.

Traders also use the strategy as a way to hedge against the risk of volatility collapse. If volatility collapses in a long call position, this can go poorly for an investor. But with the structure of a call debit spread, changes in volatility don’t have much effect.

Call Debit Spread Tips

Here are some tips for trading call debit spreads and some additional factors to be aware of before opening your first call debit spread.

Sensitivity to Theta (Time) decay

One factor that impacts call debit spreads is time decay, or theta decay. Theta is one of the Greeks in options trading.

If the underlying asset price is near to or below the long call (lower strike price) the trade will decrease in value as the expiration date nears. However, if the asset price is near to or above the short call (higher strike price) the trade will increase in value as the expiration date nears.

If the asset price is near the middle of the strike prices, time decay of the long and short call is offset and time erosion will have little impact on the price of the call debit spread.

Closing Call Debit Spreads

It’s generally a good strategy to close out a call debit spread before it expires if it is profitable. If it has reached its maximum possible profit, the position should be closed out to capture the maximum gain.

Another reason to close a call debit spread position as soon as the maximum profit is reached is due to the risk of your short call being assigned and exercised. To avoid this situation you may close the entire call debit spread position or keep the long call open and buy to close the short call.

If the short call is exercised a short stock position is created. You can close out the position with stock in your account, buy back stock in the market to close out your short position, or exercise the long call. Each of these options will incur additional transaction fees that may affect the profitability of your trade, hence the need to close out a maximum profit position as soon as possible.

Call Debit Spread Summary

Below is a summary of the key factors involved in a call debit spread:

Maximum Profit	Limited
Maximum Loss	Defined
Risk Level	Low
Best For	Prediction of an upward movement in stock price
When to Trade	When bullish on a stock
Legs	Two legs
Construction	Short call + Long call
Opposite Position	Call credit spread

The Takeaway

A call debit spread is a commonly used options trading strategy that can help traders have predictable risk and profits when they are bullish on the underlying asset.

If a trader wants to take a long position on an asset, but not have to buy the asset itself, they can use the call debit strategy — which gives them exposure to the asset with less risk and lower capital requirements.

It’s also possible to use this strategy as a way to hedge against the risk of volatility collapse.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

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Guide to Moneyness in Options

What Is Moneyness?

How Does Moneyness Work?

Understanding Intrinsic and Time Value of Options

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Types of Moneyness

In-the-Money (ITM)

Out-of-the-Money (OTM)

At-the-Money (ATM)

Near-the-Money

Other Moneyness Terms

What Moneyness Means to Investors

The Takeaway

FAQ

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How Is Option Volume Calculated?

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What Do Option Volume and Open Interest Indicate About Options?

Fundamental Analysis

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Technical Analysis

Technical Analysis, Other

The Takeaway

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LEAPS Options Defined

How to Buy LEAPS Options?

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What Are the Pros & Cons of LEAPS Options?

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What Are Some Helpful LEAPS Options Strategies?

Invest in LEAPS Options with SoFi

Strategic Overview: What Is a Cash-Secured Put?

The Details of Selling a Cash-Secured Put

What to Consider With Cash-Secured Puts

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Pros & Cons of Cash-Secured Puts

What Are the Pros of Cash-Secured Puts?

What Are the Cons of Cash-Secured Puts?

Tips for Employing a Cash-Secured Put Strategy

Looking to Start Trading Stocks? Invest Today with SoFi

What Is a Call Debit Spread?

Call Debit Spread Definition

Entering and Exiting a Call Debit Spread

Call Debit Spread Examples

Example 1

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Example 2

Maximum Gain, Loss, and Break-Even for Call Debit Spread

Why Trade Call Debit Spreads?

Call Debit Spread Tips

Sensitivity to Theta (Time) decay

Closing Call Debit Spreads

Call Debit Spread Summary

The Takeaway

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