Fighting Time Decay With Vertical Debit Spreads

Looking inside vertical debit spreads with Senior Market Analyst Joe Hargett

Managing Editor
Mar 3, 2023 at 3:17 PM
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Subscribers to Chart of the Week received this commentary on Sunday, February 26.

Before we unveil chart of the week, we have a special offer that should not be ignored! Schaeffer’s Vertical Options Trader – the same service we’re about to discuss – has an amazing LIFETIME deal currently running. Click the link below for a lifetime subscription of VOT for only $995!. That’s over 50% off! But don’t take my word from it, keep on reading to see how VOT trades can almost quadruple your money in under two weeks! Yes, that sounds like an informercial, but its actually true. Find out how below!

Schaeffer’s Vertical Options Trader

“Tiiiiime, why you punish me?” Darius Rucker of Hootie and the Blowfish sang that in 1994. It’s an existential song that many an option trader has sung. In the options market, trading stock direction usually involves buying or selling a call or put option. One of the most significant disadvantages of options trading is the erosion of extrinsic value over time, measured by theta.

Never fear, options traders and 90’s alt rock fans, for there is an options strategy that limits the impact of time decay. Earlier this month, subscribers to our Vertical Options Trader service scored a 274% profit in just under two weeks on our recommended Coinbase Global Inc (NASDAQ:COIN) February 17, 55-65 vertical debit call spread. Unpacking the highlights of this trade underscores the utility of the vertical debit spread.

A vertical debit spread is achieved by buying an at-the-money (ATM) option and selling an out-of-the-money (OTM) option in the same expiration month. The credit received from writing the OTM option offsets the entire cost of purchasing the ATM. Unlike other strategies, the risk is limited to the difference between the costs of the extended leg and the income from the short leg. As a result, this type of spread is especially effective when trading options.

COIN Chart COTW Bernie

 

Here’s what Senior Market Analyst Joe Hargett had to say about vertical debit spreads: “A vertical debit spread can consist of ATM, OTM or in-the-money (ITM) option contracts – it just depends on your goals for the trade. Bernie’s trade that we’ll get to below uses two OTM options to construct the spread. The credit received from the sold OTM option does not cover the entire cost of buying the purchased option in the spread. The risk is limited to the difference between the credit received from the sold option and the premium paid for the purchased option, while the maximum profit is capped at the difference between the spread between the sold and purchased options and the premium paid for the entire spread. This is both a blessing and a curse for spread trades, in that your upside is clearly capped, (so you have to structure your spread accordingly) but it also sets your target gain from the start of the trade. In other words, you automatically limit your greed with this trade.

As an aside, if you want to hear more from Joe, check out his most excellent podcast debut below!

 

 

When COIN was recommended on Jan. 20 by founder and CEO Bernie Schaeffer, the cryptocurrency platform had taken out its 200-day moving average, as speculative assets such as Bitcoin (BTC) sprung back off the mat to hurtle past $20,000 to start 2023. The $10 billion market cap level was reclaimed in the process, and the shares were testing support at 50% above its Jan. 6 lows.

Bernie also noted a November 2022 cover story from The Economist, titled “Crypto’s Downfall.” We’ve discussed the cover story fallacy in this space before, but COIN’s recent strong price action offered up some contrarian implications that couldn’t be ignored. With these trade drivers in mind, the spread went as follows: buying (to open) the February 17, 2023 55-strike call and selling (to open) the February 17, 2023 65-strike call.

With COIN trading at $49.92, the stock proceeded to gap higher by 11.6% the next trading day. It then rattled off outsized moves of 15.8% on Jan. 27 and 12.4% on Feb. 1, trading as high as $65.30. The next day on Feb. 2, COIN gapped higher again, and trading at $71.50, Bernie instructed subscribers to sell 50% (first half) of the vertical debt spread position. The next day, with COIN trading at $73.16, the second half of the position was closed, for a total overall profit of 274%. Options traders had nearly quadrupled their money in the span of two trading weeks.

COIN Chart COTW Postmortem

 

This was, in a way, the perfect options trade. It factored in contrarian indicators for the underlying equity, macro tailwinds, and a strategy catered to stocks expected to move strongly in the period encompassed by the date of recommendation to the option expiration date in the following month.

FREE: Schaeffer’s Top 2023 Stock Picks!

Schaeffer's Market Mashup Podcast: Threading the Needle With Joe Hargett

 

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