Wednesday, November 19, 2008 | home | blog | portfolios | weekly pick |
How to Add Income to Your Account Today!! One of the quickest, easiest ways to generate income into your portfolio is by using the credit-spread strategy. In today's lesson we are going to examine credit spreads and illustrate how you can start to incorporate this strategy to your investment approach and start to see income today! First, let's look at the basic strategy of the credit-spread. To initiate a credit spread position, you will be simultaneously purchasing one option on a security and selling another option. Both options will have the same strike month, and be similar in nature (both puts or both calls) but have different strike prices. Example #1: The Bull Put Credit Spread: Our first example is going to use the bull put credit spread strategy. It sounds more difficult than it really is. Basically, we are using stocks that we are bullish on, using PUT options for our spread, and setting up the position to generate immediate income into our accounts. Advantages:
Let's look at an example to explain the above advantages. Let's first look for a stock that we are bullish on over the next 2 to 3 month horizon. SIGN UP FOR YOUR FREE MEMBERSHIP TODAY!! For our example let's use F5 Networks Inc (FFIV). F5 Networks, Inc. is a provider of application traffic management products. The Company develops, manufactures and sells products and services to help companies efficiently and securely manage their Internet traffic. FFIV is currently trading at $53.15. Let's now look at the advantages a credit spread trade has over simply buying the stock. We are going to look at setting up FFIV bull put May '05 credit spread. In setting up bull put spread we are going to simultaneously sell an out of the money put while buying a deeper out of the money put. Let's simplify this by looking at the numbers:
Trading 10 contracts would create a credit in your account today of $450!!! That's a 9.8% return for a little under 45 days. Where did the 9.8% come from? To compute returns on the spread you take the credit $0.45 divided by your amount of capital at risk Capital @ Risk = Difference in strike prices, less the initial credit received. So in our example:
Too good to be true? Perhaps. Let's talk about what can go wrong before we move forward. How can this investment go bad? Simple, the investment will start to move against us should the value of the stock drop below our sold put. Remember, FFIV is currently trading at $53.15. So, in order for this position to go against us the stock would have to drop $13.15 or 24.1% !!! SIGN UP FOR YOUR FREE MEMBERSHIP TODAY!! Amazing, our profit will be the full 9.8% should the stock climb, stay at its current level or even fall in excess of 20%. Not too many investments can offer you those returns! Next week will discuss this strategy further as well as check in our this trade to see how it unfolds. If there is a specific topic you would like addressed please do not hesitate to contact us and make a request, we are always looking to hear from our readers.
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