Methodology of the DITM Vertical Bull Call Spread

Y

yucca_mtn

I have been using the DITM Vertical Bull Call Spread for personal trading for well over a year now with good success. This strategy is ideal for me because, although I have been reading about option trading for nearly three years on this forum, most of what I read was boring or over my head. That said, isn’t it interesting that I’m posting a new thread?

The Deep in the Money Vertical Bull Call Spread is created when you buy a call with a strike price that is (roughly) 3 levels below the underlying stock price, and you sell a call with the same expiration date but with a strike level above the long call.

For example: XYZ stock at $88, you buy a XYZ DEC07 75 call and sell a XYZ DEC07 80 call.

The idea is to pick a strike date and strike levels that produce a yield (on an annualized basis) of about 50%, using an underlying stock that will offer a high safety margin.
I usually like to work with calls that are 6 months from expiration to get yields of 25%. I go as deep as I can and still get the 25% yield. This choice seems to allow me to stick with good quality companies and avoid the high volatility junk out there. I start out (usually) with a 1 strike level spread, so I have flexibility if I need to tweak it as the stock price does it’s thing.


This is some of what I have learned, and I hope to learn more if this thread sticks:

1. This is a fairly easy strategy for novices to implement.

2. This is a non-technical strategy, at least the way I use it.

3. The safety of the strategy has proven to be incredible, for my trades to get in trouble the stock has to drop 15 to 20% (usually), otherwise I make the full profit.

4. Using a spread offers many opportunities for position management moves.

5. Using a spread methodology offers a lot of flexibility at tax time.

6. Sector selection, entry timing is very important in stock selection. Like, of course! But the point is I work as hard as any long-on-stock guy to pick stocks that will be successful during the next six months. But if the stock drops 10%, I’m still smiling and he is wringing his hands. Naturally I need enough Volatility in the stock to get the yield I'm looking for.

7. The positions do not require daily maintenance and I sleep well at night. Weekly monitoring is sufficient. I monitor and tweak a lot because I love it, and I can see more opportunities to make the position yield more or be made safer, but I don’t have to with six month time frames.

8. Early exercise, and expiration issues can get interesting in DITM spreads.

I hope we can discuss in some detail the topics related specifically to this type of strategy. You can contact me to send you more info on my experiences, thoughts and ideas about this strategy. I have complied a document that will inform a rank novice how to do this and I would be happy to send it to anyone who asks.

Peer reviews can be tough, lets keep it clean guys!
 
Hi Yucca,

While I wish you great luck with your trading and really do hope you'll be successful, it's hardly surprising that a rough equivalent to a covered-call strategy worked well in one of the best bull markets in years.

You could have easily sold naked puts, saved yourself a lot of margin, and come out ahead.

The question is, what will happen in a non raging bull market? Take a look at the CBOE Buy-Write index and compare it to the S&P 500 to see how your strategy will perform in a bear market. It will perform better than simply owning the stock, but any "yields" you've earned so far will be sucked away more quickly than you'd expect.

Anyway, beware of choosing strategies based upon the market. If this bull market will continue forever, your strategy is great. If not, it isn't.

Best of luck.
 
from FullyArticulate.

"The question is, what will happen in a non raging bull market? Take a look at the CBOE Buy-Write index and compare it to the S&P 500 to see how your strategy will perform in a bear market. It will perform better than simply owning the stock, but any "yields" you've earned so far will be sucked away more quickly than you'd expect.

Anyway, beware of choosing strategies based upon the market. If this bull market will continue forever, your strategy is great. If not, it isn't.

Best of luck."

I hear you. I did not just ride indexes though. I was challenged a great deal on many of the positions I opened. For example I was pretty heavy into the oil sector when it ran aground in Sept06. I also had positions in the builders stocks last year and need I mention medical stock problems?

The positions that gave me the most hearburn were also the positions that taught me the most about position management moves that minimized losses and risk and maximized profits.

I did not say that my year was easy, and I made a lot of mistakes that I won't repeat, but that is why I started this thread to get others ideas and to pass on what I learned. Even with all that said. I still posted a 40% in my entire portfolio.
 
reply to maverick


I looked at that too. All I can say is that using the put strategy is not as intuitive for me as the blatant in-your-face Bull Call spread.
It i obvious as can be that buying a spread for $4 and selling it for close to $5 or letting it exercise for $5 is profitable. I don't have to worry about credit spreads that leave me with large obligations on my funds.

By using debit spreads, I know at a glance how much available funds I have, what my margin requirements are, etc.

However using DITM Vert. BEAR PUT debit spreads when the market is trending bearish is something I can and will do, because of the same reasoning.

Too many words. In a nutshell I like debit rather than credit spreads.
 
Mav is right. If you use an OTM debit spread, you can often expire both legs, which saves a lot of money. You avoid early assignment issues. The options are more liquid and often will have smaller spreads. Plus, for me the pyschological aspect is exactly the opposite of what you feel. I like to get the money up front.
 
First of: option spreads is what I do too.
This year was really good for me as I posted 100% success on all trades.

40% of my trades are condors which is bearish OTM calls and bullish OTM puts.

As others indicated in the thread I prefer OTM spreads as your capital outlay is lower.

Currently I have plenty of bearish OTM call spreads on things like GOOG, RIMM and other overloved puppies.

However, my whole portfolio is up only 30% this year, so I'll be happy to learn from you.

Please post your ideas so we can discuss them.
 
reply to AAA

I do not disagree with you and maverick - yet!
But I would need to rethink position management moves, since I'm not used to thinking that way.

for example, in the hypothetical spread mentioned in the first message, the stock of XYZ drops from $88 to $83.

So the spread value might be $3 instead of the $4 I paid.
Depending on my view of the prospects for the stock, I might choose to just wait for the position to improve, or I might select to roll it.

With my position I can if I choose roll down the long leg by buying a 70/75 spread for maybe $3.5, then my position would then be a
XYZ Dec07 70/80 spread with a cost of ($4 + $3.5) $7.5.

Now I have a lower breakeven point of $77.5 on the stock price. Plus of course I have a paper loss on the 75 call I bought back, that is partially covered by the paper gain in the 80 call.

So, how do you do an equivalent move in puts?

Also, I understand that with puts you get the $100 up front, also you get an obligation on your funds for $500. That probably shows up in "available funds", but it doesn't chow up in "cash"

I agree about the market thinness of the DITM calls, but it has rarely been a problem when I wanted to exit a position early.


I'm not running away, but I am going to watch the superbowl.
 
You must log in or register to reply here.
Back
Top