Options Trading: STRATEGIES (Part 2) | Scott Reese | Skillshare

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Options Trading: STRATEGIES (Part 2)

teacher avatar Scott Reese, Engineer & Investor

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Lessons in This Class

6 Lessons (56m)
    • 1. Introduction

    • 2. Jade Lizard

    • 3. Ratio Spread

    • 4. Broken Wing Butterfly

    • 5. Calendar Spread

    • 6. Wrapping Up

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About This Class

Options are one of the most versatile financial products in existence. Whether you are bullish, bearish, or even neutral on certain stocks or the market as a whole, you can use options to craft a strategy with your market assumption in mind. You can even use options to generate profit simply from the increase in fear (or volatility) in the stock market! This course will introduce you to 4 options trading strategies that you can utilize to generate profit in all of these scenarios!

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Scott Reese

Engineer & Investor


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1. Introduction: Hey there. Welcome to my second installment of my options trading strategist courses where in this course will be learning about some more nuanced strategies, such as the J lizard. The ratio spread the broken wing butterfly on the calendar spread. One of the coolest things about options trading is that there are a massive variety of ways to combine buying and selling options that allow you to play the markets. However you want. Whether you want to make money when stocks go up, down sideways, or even when the general fear or volatility, the market increases trading options. That allows you to do all of that, and the strategist toughens course will show you how. Now one thing to note is this course does require just some basic knowledge on how options work and some of the more common strategies, such as debit spreads and credit spreads. So if you are brand new two options, I suggest you first watch some of my more introductory courses, the first of which is called Stock Market Options introduction, and that will teach you exactly how options work. And then you can also watch my first installment of my options trading strategies courses to get you up to speed if needed on those credit spreads and debit spread strategies. And lastly, this is the first course of mine that you've come across just a little bit about myself. My name is Scott Reese. I currently work as a soft engineering, the financial services industry, and I'm also an options trader and my core strategies all about selling options when implied volatility or the general fear in the market is elevated and all my trades are based purely off a probability. So you'll find that a lot of the strategies that I teach actually allow you to take in money initially, when you enter the position as opposed to paying money, and they will give you a 60 70 or even 80% chance of keeping that money as the trade plays out over time. So that being said, let's hop in and get started with the jade lizard 2. Jade Lizard: All right, Welcome to the first video, this course, and in this first video here will be talking about the jail lizard, which is going to be basically a combination of both the strangle and the Iron Condor. So going to the trade tab here, what I have already pulled up is the option change for Apple stock Left hand side here. These are all the call options and the right hand side. These are all the put options, and all these contracts expire in the August expiration cycle, which is about 26 days from now. And currently Apple is trading for about $370 per share. Now, just as a quick recap, the strangle is basically when you sell both a naked call option and and make a put option on either side of the stock and both those options being out of money. And when I say naked, that basically means you don't have any protection. Necessarily. If the stock has a massive move either to the upside or to the downside, and the Iron Condor is just the defined a risk variant of the strangle. Right? You basically still sell a naked call and then they could put on both sides the stock. But further out of the money. You then purchase a put option and purchase a call option that gives you defined risk so that no matter how far the stock actually moves over the course of the expiration cycle, you will only ever lose a certain limited amount of money. Now is it said the J lizard is going to combine these two strategies in that on one side of the stock, we're going to sell a naked option, no protection. And then on the other side, we're going to sell a vertical spread, a defined risk position so that on one side that we can only lose a finite amount of money . And on the other side, we technically have that undefined risk. But no one in the history of options trading has ever lost an infinite amount of money, right? It simply means upfront with an undefined risk position. You don't know how much money you could lose if things go wrong, but this is still going to be a very high probability of profit position, and moreover, it's really only gonna have risk toe one side and you'll see how that works out in many here. So as an example, I'm going to set up a J lizard on Apple stock here, and I'm going to be selling a vertical call spread as well as a naked put option. And you could do this both ways. You can have your naked option being on the call side, so just selling a naked call and then selling a vertical put spread. But it really doesn't matter how you do it and mostly just depends on what your assumption is. For Apple stock, this is basically a neutral strategy. Ideally, we want Apple to remain in a certain range. But if we are worried, for example, if I'm worried that Apple stock may just keep climbing higher and higher and higher than that's why I'm going to be selling a call spread a defined risk position and a naked put option on the other side of the stock so that if Apple does in fact just keep climbing and it does not just stay within a nice range, we will actually still be able to make a profit on this position. So on the call side here I'll go ahead and set up a vertical spread. And we're gonna do a $5 widespread so going to sell the 382.5 strike call. And then we're going to purchase the 387.5 strike. Call $5 wide right, $5 difference between the strikes you could see well, taking a credit of about $105. Now, just as a reminder with defined risk positions like a call spread, for example, that we have set up here that most we can lose is simply the difference between the strikes times 100 basically. So it's a $5 difference. Multiply that by 100 so $500 then you subtract from that the amount of credit you receive, so $500 minus 105 is $395. So if Apple stock has a huge rally and it blows through both of our call strikes, the most we could ever possibly losing his position is $395. So now that we have this call spread, sit up. Now I can go over to the put options And now I'm just going to sell a naked put option. Not gonna buy anything as protection, just a straight up, naked put option. And the key here is you want to choose a strike such that you can collect enough premium to cover the maximum possible loss on your credit spread. So is example I might be looking to sell this 340 strike put. We'll set that up there and going in between the bid and the ask here. I could probably sell this for about $410. So sitting at that limit order $410. And there you go. This is my overall order for the J Lizard. And so now, like I said, with the call spread the most we could ever possibly loses $395 You can see here with the put option that we're also going to sell. We're collecting a credit of $410. So if Apple stock just had a huge rally and it blew through both of our call strikes, we would lose $395. But our put option would just expire worthless and we would get to keep the full $410 that we initially took in when we sold the option. And so this obviously more than compensate for our $395 loss and will still walk away with a small but still a legitimate profit. So show this more clearly in a visual way. Then they go to the analyzed tab here. So this is the payoff diagram for R. J lizard position. The Blue line represents the profit and loss curve by expiration, and the Purple line represents our profit Last curve right now as of July 26. But I'm mostly gonna focus on this blue line here in this middle brown dash line right here . This represents the current stock price of Apple. We can see right here about $370. The X axis is simply represents the stock price of apple as it fluctuates back and forth. And my cursor will represent that as I move my cursor, that's going to basically represent the price movement of Apple stock and then on the Y axis here. This represents our actual profit and loss, depending on where apple stock actually moves in price. So because we sold our call options and are put options out of the money on both sides of the stock, right are short. Call is at $382.50. That's the strike price and are short put. Is that a strike of 3 40 with Apple trading in about 3 70? Clearly, we're in the most profitable region of our strategy. The J Lizard, as I said, is ideally a neutral strategy. We want Apple to remain within this range right here. So, ideally, over the course of this expiration cycle, we want Apple to stay above $340 right? That's our short put strike and below $382.50 right? That's our short call strike. As long as Apple stock stay somewhere within this range by August expiration, we will get to keep the full credit from selling both this call spread and this naked put option right $410 in credit for the put option, plus $105 for this call creds spread, adding the two together. Our overall net credit is $515 so long as Apple stock stays above $340 per share and blow 382. Then all these options will expire, worthless by expiration, and we will get to keep the full $515 now. That, of course, is the ideal scenario. But again, the main reason why we are putting on this position is if we are a bit nervous about the upside. If we think Apple stock might just continue climbing higher and higher and higher than this J lizard with the call, vertical spread will protect us from losing money. If that does happen, you can see here as Apple starts climbing and it starts. Testing are short call strike at $382.50. Obviously, we have over $500 in credit to offset losses as Apple goes further above are short call strike You see down here this blue number as it's fluctuating based on where I move my cursor, you can focus on that to see what are exact. Profit or loss is depending on where Apple stock trades, So focusing on the number of as you can see is If Apple stock climbs higher and higher above are short call strike, we will be losing our profit. But we'll still be probable to some degree because again, we do have that $500 in credit to offset losses. But at some point, basically, if Apple blows past are long call strike at $387.50. Now both of those options air in the money and we will lose the full $395 right? But because the naked put option that we sold was with $410 when he sold it, that's going to offset entirely that $395 loss and will still walk away with $15 profit, no matter how high Apple stock actually climbs thereafter. Of course, that is still a very small profit. But have we just done an iron condor or just a normal strangle? Then, if Apple just kept climbing higher and higher and higher with ER in Kander, we would simply lose the $395 right, and there's no way to get around that. And if it was a strangle, well, that's an undefined risk position. So if Apple stock just kept climbing higher and higher than our losses would just keep getting greater and greater. And by expiration, wherever Apple stock is, then at that point, we can actually look and see what our total loss is. But this J lizard obviously protects us from that possibility. Now, of course, with this naked put option, we do have undefined risk on this side of the trade. So if we are completely wrong, an Apple stock does not trade within a nice range, or it actually does not rally like we were kind of nervous about. But instead, it totally falls and drops well below are short put strike, then, Yeah, we're in a bit of trouble because we do have undefined risk on this side and we don't know up front how much money we could lose. That is simply the risk that comes with this kind of strategy. But once again, keep in mind with our total $515 in credit. Even if Apple does go a bit below are short put strike at 3 40 we can use that credit to offset losses. So this red tick represents our break even point. So even if Apple falls all the way down to about $335 or so, we will still basically break even on this position. And, of course, of Apple drops even further than at that point yet we will start losing money on this trade , and we might have to make adjustments or just close out altogether to cut our losses. But do you also keep in mind that the chance of this happening the Apple falls all the way below are short put, strike and even goes further? Pastor break even point. The chance of that happening is very low again. This is a very high probability of profit trade. I go back to the trade tab here and by Holly are short put strike at 3 40 You can see this put option only has about a 22% chance of being in the money on the day of expiration, which, as reminder, means there's basically a 22% chance that Apple actually falls all the way from 3 70 down to or below 3 40 by August 21st. That's a very low probability. Moreover, our break even point is actually around 3 35 and we can look at the probability in the money for this put option with the 3 35 strike to get an idea of the chance of that happening. And we can see that there's Onley in 18.5% chance of Apple going from 3 70 all the way down to 3 35 which is our break even point. So an 18% chance that we literally just make no money or losing money on this trade, and we just get to walk away and find a new trade. It's only below this point where we actually start to suffer losses. And, as you can see as you go further down the option shame. The probability that apple falls down to these levels is in the single digits. So if you wanted to calculate your probability of profit on this position, you simply take 100 subtract from it. The percentage associated with your break even point again. 3 35 is basically are break even point, give or take a few pennies, so 100 minus 18.5 is 81.5, so you basically have right around in 81.5% chance of making money on this position. And I hope that alone can show you why I in particular and many other option traders really prefer to trade options in this manner, right, basically selling premium or selling options. So we taken a overall net credit and giving ourselves high probability set up so that most of our trades actually make money. Of course, if we were to make these same kind of J lizard trades over and over and over again about 18 to 20% of time, we would lose money on these trades. But that's a very small percentage of the time. And just as a side note, you know, this is why I pretty much exclusively trade options and almost never trade stock if our to buy shares of Apple stock or short sell shares of Apple stock. The only way to make money on those kinds of trades is if the stock price moves in my favor from the point at which I bought it. If I bought Apple at $307 per share and of course you know, going long on Apple means I can only make money if the price increases from there. That's basically a 50 50 shot of that happening right. If you look at these options that are basically at the money, you can see there's about a 50% chance that this option is in the money by expiration. So when your trading stock, it's pretty much always a 50 50 chance of either making money or losing money, and there's no way to actually change the probabilities in your favor with options. However, there are plenty of different strategies that you can utilize that allow yourself to get into position with a very high chance of making a profit. Whether that be 60% 70 80 85 90 you just saw with this J lizards and over an 82% chance of making a profit. And the more you make these kinds of trades, you will see these probabilities play out very accurately over time. So I believe that wraps it up for the J lizard again. Just to recap is basically a combination of the strangling the on Condor, where on one side of the stock, you're selling a naked option and on the other side you are selling a defined risk vertical spread, and the key here is the naked option that you're selling the amount of premium, or that a credit that you collect for slaying. The option must be greater than your maximum possible loss on the defined risk of vertical spread that you're selling on the other side of the stock. And the J lizard can be set up both ways in terms of selling, as you just saw in this video. Eight. Call spread To protect ourselves from the possibility that Apple stock may just keep rallying and will still be able to walk away with a $15 profit or if you are instead nervous about Apple stock falling in price, then you can sell a defined risk. Put vertical spread on this side and then selling naked call. Either way, you'll still only have really risk on only one side of the trade, and you will still have a very high probability of making a profit. Assuming you're selling options on both sides that are out of the money and in the next video coming up, we'll be talking about ratio spreads 3. Ratio Spread: All right, welcome back to the next video, this course, and now we'll be talking about the ratio spread, which is a strategy that's basically going to combine both the vertical debit spread, whether that's a call debit spread or a put Deborah spread, depending on what your directional assumption is fortune for whichever stock you're looking at. So it's giving a combination of that, plus selling another hour to the money option to finance that vertical debit spread. So to help make them more clear and they go over to the trade tap here and I have pulled up the Twitter option chain again on the left. Yet the calls on the right of the puts and all these options expire in the September expiration cycle, which is 49 days from now. Twitter's Crimen trading for $36.40. So the scenario that I'm gonna be walking you through is, let's say I'm bearish on Twitter. You know, if I go to the charts, for example, you could see that over the past few weeks, Twitter has had quite a bit of ah, rally, and so you can see now that it's kind of coming down a bit. Perhaps. I think this downward trend is gonna continue. Um, so I'm bearish on Twitter and one of the ways, obviously you can play Twitter to the downside or any stock to the downside is by buying a vertical put debit spread, which, as a reminder, just means I'm going to be buying a put option That's much closer toward the stock is trading and then also gonna be selling an option that's further out of the money and the overall cost of doing something. This is gonna be a debit that I'm going to pay to get into this position. So if I think it's likely that by September expiration that Twitter is gonna fall down below $35 per share, then you know it would make sense for me to buy this 35 strike put and then perhaps sell the 33 strike put and thus making a vertical put debit spread. Let me go ahead and set up that order. All right. So you can see here that we're buying one put option contract expiring in September 35 strike and then the same time also selling one contract with a strike of $33. And to get into this position, we're gonna be paying an overall debit of $70. And the reason why we're we have to pay a debit for this vertical put debit spread is simply because the option we're buying is much more close to where the stock is. Trading and options closer toward the stock is trading are always gonna be more expensive than options. Further way. So because we're buying a more expensive option and then selling a less expensive option. The overall outcome of that is we have to pay 70 bucks to purchase this. Put David spread. So ideally, of course, we want Twitter to fall well below 33. That's where we get to enjoy the maximum possible profit on this position, right? Just as a reminder again, the way you calculate the max profit on a vertical debit spread as you take the difference of the strikes. So 35 minus 33 is to multiply that by 100 200 and then you said track from that, the debit you pay so 200 minus 70 is 130 So the maximum possible profit we can make on this trade. Assuming Twitter Falls blower, a long strike of 33 is 130 bucks. And because this is a defined risk trade, that means if we're wrong and Twitter just continues to rally higher and higher and higher , then the most we could lose in this position is simply the $70 debit that we paid two purchases debit spread at the beginning. Now this debit spread by itself is not a terrible trade, right? You obviously have some pretty good risk reward. Its Twitter doesn't have to fall too far for you to make some amount of money on this position. But if you've watched any of my other courses, you will know that my core strategy is all about selling options and taking in a net credit . And in doing so, giving yourself a high probability of success on every trade and the reason why I trade that ways because, statistically speaking, giving yourself high probabilities of success or high possiblities of profit on every trade basically greater than a 50 50 shot at making money generates a positive expected outcome of actually generating profits consistently over a long period of time and so coming back to this debit spread, we obviously need Twitter to fall below $35 per share before we even have the chance of generating some kind of profit on this strategy. And if you look at the probability of Twitter falling down below $35 per share, it's only about a 44% chance of that happening. Moreover, just because Twitter falls to right around $35 per share, that does not mean we get to walk away with a profit. That's because we still have to pay upfront 70 bucks to get into this position. So this debit spread needs to first generate more than $70 in profit before we actually get to walk away with some sort of net return. And the only way that can happen is if Twitter actually falls to below $34.30 below that point is, debit spread by expression will be worth more than 70 bucks, which is obviously more than what we paid for it. And as long as Twitter states below 34 30 then yeah, we get to walk away with. Hopefully if it falls below 33. That full $130 a potential profit. But if you look at the probability of the 33 strike put being in the money, that's only about a 31% chance of that happening, which means there's about a 70% chance of that not happening. And so I hope that were off. The bat tells you that the odds of making that full $130 max profit or really any sort of profit on this trade is not in your favor. The odds of actually making money on this position or less and 50 50. And so this is where the second component of the ratio spread strategy comes into place because we're now going to, on top of this debit spread, going to sell another out of the money put option. So instead of buying 1 35 strike put and only selling one of the 33 strike puts, we're still going to buy one of the 35 strike puts. But now we're going to sell two of the 33 strike puts, so I go ahead and set that up. All right, so here you go. You can see once again, we're buying just one Twitter put option contract 35 strike put. And now, selling two of the 33 strike puts over here is where you can see the pricing. And so now, if we're selling two of these 33 strike puts, that means we're taking in $204 in credit. And then of that $204 we have to pay out only 1 75 to buy this more expensive option. So in the end, we still get to walk away with an overall net credit. And this is what I mean when I say that the extra out of the money put option that were selling is financing this debit spread, right? Don't forget this ratio spread strategy still combines under the hood. That debit spread with the naked put in this case. So the debit spread portions still cost us money, right? Still, an overall debit to buy that put spread. But because we're selling another out of the money naked put option, the additional credit we were see from that put actually more than compensates the cost of that. Devon spread so that in the end we get to walk away with an overall net credit as opposed to paying a net debit. And that also means that if I'm wrong on this trade, right, I'm obviously bearish on Twitter and I wanted to come down in price. But of course there's always the chance that I'm wrong. I think continues to go higher and higher and higher than in the worst case. If that happens, I still get to walk away and keep that net credit. Let me go to the analyzed tab here so you can see this in a visual way once again has reminded the blue Curve. Here is our profit loss diagram for this position based on the expiration day and the X axis represents the stock price of Twitter. And my cursor, of course, represents where Twitter stock is actually gonna move in my hypothetical scenarios. And the Y axis represents our actual profit and loss based on where I move my cursor. And the current actual stock trading price of Twitter is represented by this middle brown dash line. Right here, $36.40 is the current market price for Twitter. So a twitter currently trading right around here. Of course, looking at this diagram. We want Twitter to fall right around into this range because this is where we generate the most amount of profit on this position. Right? This is a bear strategy that we have set up here. And so, of course, it would make sense that if we are correct and Twitter does fall, that we would generate the most amount of profit on this trade. But just as you saw with the J Lizard in the last video, if we are 100% completely dead wrong on the strategy and Twitter goes from 36 to 37 38 39 40 45 just never comes down, then we will still get to walk away with a small but still legitimate profit. And that's because the additional put that we sold to quote unquote financed that put debit spread allowed us to enter this entire position for overall net credit. Right. If you do the math, your if we sell two of these puts for $102 credit apiece, so maybe $204 in total. And know that $204. We have to spend 175 to buy this 35 strike put. That leaves us with $29 left over, and that's our net credit. And looking at these numbers right here specifically, this blue number, this is our actual profit and loss based on where I move my cursor right, and so, anywhere above $35 per share, which is basically our zone of being 100% completely wrong, right anywhere above 35 you can see that we will always get to keep that $29 credit, no matter how wrong we actually are. But of course we would love to be right. And so if we are, then D point at which we get to generate the most amount of profit on this position is right here at the peak of the strangle which happens to fall right on our short put strikes of $33 per share and below that point, we still remain profitable, although it's decreasing as we go further and further down, up until we hit the break even point. And then, of course, below that we actually start to lose money on this position. And so this is where the main trade offs come into play. Between this ratio spread and the normal just put debit spread by itself. You know, with the put debit spread, we simply pay the $70 debit upfront, and that's the most amount of money we could lose. But of course, we don't have a huge or high probability of actually making money in that trade. With this position, we have a very high probability of making money. This trade basically anything above our break even point, which is $30.70 per share. So anywhere above this point, we get to keep at least the minimum credit that we took in when we place this trade. But of course, by selling this additional put, that's a naked put right. We have undefined risk on the downside. So it Twitter just has a catastrophic collapse and just falls away way below our break even point. We could suffer some pretty serious losses, and that's just part of the risk that's associated with making a trade like this. But moreover, as you also sell it, the J Lizard, which has a very similar component to this ratio spread. The chance of this happening is very low, right are break even point. There's $30.70 per share. And so I go to the trade tap here, and I'm just gonna round up and go to the put option with a strike of 31. The chance that this option is in the money by expiration, which also means the chance that Twitter actually falls down below $31 per share is only 21% which means there's about an 80% chance that never happens. And this is our break even point. That means there's about an 80% chance that we get to walk away from this trade with some sort of profit, whether that's the maximum possible if Twitter falls down to exactly $33 per share or it's simply the minimum net credit that we took it initially, if we are completely wrong and Twitter just keeps going higher and higher and higher in the chance that something absolutely catastrophic happens to Twitter and you know, let's say the chance of it falling all the way down to $25 per share, there's only a 6% chance of that happening. And, of course, that's greater than zero. Obviously, it certainly could happen. But if it did, you would likely have plenty of time along the way down to make adjustments or simply close out of this position entirely to cut your losses. Just because you enter a position you enter into this ratio spread does not mean you can't exit it at any point that you want. So now, going back to the analyzed tab so as a big interrupt things up here, the key takeaways from the strategy are. If you're looking for a high probability trade that has a chance to generate some significant returns, this could be a good option for you if you recall from the J. Lizard, for example, the amount of credit you initially took in from putting in that position. That credit is your maximum possible profit on the trade of everything goes well with a ratio spread here. You still take in some credit, of course, but you could generate way more if the stock actually does move in your favor, right? The maximum profit in this case is run around $229 I should mention a little bit about the actual naming of this kind of strategy, the ratio in the name ratio spread or, 1st 2 the actual ratio between the options you are selling and the options you are buying. So this would be referred to as a to buy one ratio spread because we are selling to puts for everyone. Put were buying and you can do whatever ratio want. You can do a to buy one like I have set up here. You could do a four by two. You can do a five by three whatever you want. The key thing to keep in mind here is whatever amount of money you have to pay for the options you're buying. You want to be taking in more credit than that for the options you're selling so that in the end you still get to enter this position with an overall net credit. It wouldn't make sense to buy this 35 strike put and then sell to of let's say, the 30 strike puts that are only trading for maybe $40 each, so that in the end you're still paying an overall debit to get into this position. The key is you always want to be doing this for overall credit, because that credit gives you that super high probability of actually making money on the trade, even if you are 100% dead wrong on your directional assumption. And, of course, you can do the same kind of set up with call debit spreads as well if you are bullish on a stock. So instead of buying a put debit spread on Twitter, if you are bullish instead, you would buy a call Devitt spread Evan cell and out of the money call to finance that debit spread. Just keep in mind that you do always have that naked component of this position, so that if something does go very, very wrong, you want to make sure that you have the mechanics in place to know when you should make adjustments or simply just close out for a loss to protect yourself in the last thing I want to leave you with before up this video up is in order to calculate your maximum possible profit on a ratio of spread strategy, you simply take the difference of the two strikes here. So 35 minus 33. That's two. Most play that by 100 that's 200. And then you add on that additional credit you and issue took game When you put on this position. In this case, it was $29 so 200 plus 29 is $229. That happens right at the short strike of $33 per share, and then they calculate your break even point. You simply take your short strike and you subtract from that the maximum possible profits. So in this case, $33 minus a maximum possible profit of $2.29 that's on a per share basis. He's $30.71 and you obviously saw that earlier when I was showing you the probabilities of that actually happening. So at this point, I believe that wraps everything up for this video. And in the next video coming up, we'll be talking about the broken wing butterfly. So I've seen the next one. Thanks 4. Broken Wing Butterfly: Okay, thanks for joining me here again in the next video, this course. And so now we'll be talking about the broken wing butterfly, which is the defined risk variant of the ratio spread that you saw in the last video. So if, for example, maybe if you're a bit nervous about selling naked options, or perhaps you don't have permission from a broker to be selling naked calls and puts, then the broken wing butterfly is going to be a great alternative to the ratio spread. So, as always, I have an example set for you. Let's go. The trade tab here is What you're seeing is the option chain for the company work, which is just slack. It's the direct messaging platform that I'm sure everyone is herded by now. And these are again options expiring in the September expiration cycle about 48 days from now, and the scenario will be walking you through is, let's say, I am bullish on work. You know, if I go to the charts, for example, you can see in the last couple weeks it's had quite a bit of a sell off, and now it's trying to rebound a bit so maybe I think this train is going to continue, and that's giving me a bullish bias on this stock is going back to the trade tab now. So, as you saw with the ratio spreading last video, that is a combination of a debit vertical spread with another selling of a naked option to finance that debit spread right in the Brooklyn butterfly. It's very similar we're still gonna also by a debit spread of some sort. In this case, since I'm bullish, it's gonna be a call debit spread. But instead of just selling a naked call to finance that spread, we're going to sell a call credit spread, and the credit we received by selling is called Credit Spread should more than compensate the debit we have to pay for the call debit spread. And moreover, it's going to give us defined risk so that if we are super super wrong on our assumption of work, and it just absolutely explodes to the upside, you know, of course, we are bullish on work, but we don't want to go too far up. But if that happens, we will only ever lose a finite amount of money and this will become more clear once I get into the payoff diagrams and all that. So once again, I'm going to first set up a debit spread on work, and in this case it's going to call a debit spread because I am bullish on the stock. So maybe in the next 48 days or so, I think it's going to climb above $30 per share. And with accruing trading for 29 55 that's I think it's a pretty good shot that in my climb , you know, another 45 cents or more within that time frame. So I've been looking to, perhaps by this 30 strike call option that maybe sell the 33 strike call option and those making the call debit spread. So I'll go ahead and set that up. All right, so you can see here we're buying one work call option September expiration Strike of 30 and then also selling at the same time another contract of work with the 33 strike and the overall debit we have to pay for this call. Debit spread is exactly $100. And so, with the ratio spread, this is where we would be selling another 33 strike naked cull option to finance this debit spread and, ideally, the additional selling of the 33 Strike Call with Mawr than compensate for this $100 debit . You can see here going to the 33 strike, call these air selling for somewhere between 155 to $165 apiece. So, yes, selling another one of these would surely give us more than $100 in credit. But with the naked call having undefined risk instead of just selling that 33 strike call, we're still going to sell it. But then we're also going to buy another further out of the money call, and that would give us a call credit spread, still taking in a credit but capping our total risk if something were to go terribly wrong . And work just has a huge rally and blows all through our call strikes. So they go ahead and said the call credit spread now. All right, so now I have the call credit spread set up. It's also a $3 widespread, just like the debit spread, but you'll notice the credit we are receiving for this is only $66. And if you're still having to pay a debit of $100 than if we enter into this entire position, we still would have to pay an overall net debit of $34 right 100 minus 66 34. That's obviously not what you would be doing, because any time you are entering into a position where you're paying a debit, you are not going to be giving yourself a high probability of making money on the trade. And the reason why we're not collecting enough credit on a $3 widespread here is because the 33 strike call any 36 strike call are both further out of the money than the 30 strike call, which is the most valuable option of all of these. So the solution here is to simply widen out the strikes of this call credit spread to collect more credit. So instead of just doing a $3 widespread, I might want to come out to old away to the 40 strike call and by that one instead of the 36 strike. So this is now a $7 widespread. But now you can see the credit we are receiving for selling this spread is $115. Obviously more than just the $100 debit we're paying for this call spread right here. So in the end, once we enter into this entire position, we were actually walking away with $15 in net credit. And once again, I go to the analyzed tab here so you can see this in a visual way. It should be a familiar shape to you from the ratio spread video you saw previously. But you'll notice on this side the trade right here, right? The part where we could actually lose money if work actually has a huge explosive rally to the upside. Our losses air actually capped. Once work hits a price of $40 per share so that if it continues to rally further from beyond that point, our losses air actually limited to about $385. That's because this additional call option with a strike of 40 that we also purchased. This is what gives us that defined risk. Moreover, just like the ratio spread that you saw previously and the J. Lizard before that, if we are directionally wrong in our assumption and work in this case actually continues to drop further in price. No big deal, because since we still took in an overall net credit of $15 even if we're dead wrong on the direction of work and maybe it falls from $29 all way down to $21 we still get to walk away with a $15 profit, which you can see right here in the spoon number 15 bucks, no matter where work moves below are long call strike of $30. And that should make sense because if work does trade below $30 per share by expiration than all these options, all these call options with strikes with 30 or greater will expire completely worthless. And we just get to walk away and keep that $15 net credit that we took in when we first put on this position. And so once again, the ideal scenario is, since we are bullish on work, we of course would want it to rally a bit, obviously not too much, because then we start taking on losses up to a certain point. So really, the ideal scenario is for work to end up right in the zone right here. Will we get to generate the most amount of profit? And just like the ratio spread, the maximum profit potential point occurs right at the short call strikes of $33 per share . And that case, our maximum profit is $315. That's because at exactly $33 for share are called debit, spread will be worth $300 are called credit spread will expire worthless. And since we also took in 15 bucks and credit when he put on this position, you just add that onto the 300 bucks that are called debit spread is worth, so 300 post 15 is obviously 315 bucks. That's where maximum profit on the trade and our break even point occurs right at $36.15 per share, which you can calculate by taking your short call strikes. In this case, it's 33 then adding on that maximum profit potential of $315. So you take 33 you add 3.15 right. That's our maximum profit on a per share basis and you get $36.15. And once again because we're taking in a net credit and because our break even point is pretty far away from the stock is killing trading. This is once again a very high probability trade going back to the trade tab here are break even. Point was just above $36 per share. So if I look at the cull option with a strike of 36 that's running down just a little bit. The chance that this call option becomes in the money or the chance that work rallies all the way to and above $36 per share, there's only about a 17% chance that it happens, which means there's an 83% chance that it doesn't happen. And that translates to an 83% probability that we get to walk away from this trade with some sort of profit, whether that's the maximum profit of 315 bucks or the minimum $15 if we are completely wrong and work just continues to go lower and lower lower. So I hope this was a bit of a review for you, since this broken wing butter fire strategy is very similar to the ratio spread. And these were great strategies to use if you are moderately directional, either bearish or bullish, and you want to give yourself a possibility of making a very nice return on a limited amount of capital that you have to put up to hold this position. And the last thing I want to mention here before up this video up is when it comes to calculating your maximum possible loss in this case is $385. It's the maximum amount of money we could lose if we're just has a huge explosive rally. The way you calculate that is, you take the width of your credit spread. So we have a $7 widespread here, 40 minus 33 a seven. Multiply that by 100 it's attract from that the maximum possible profit you could make from this trade. So the maximum profit on this trade was 315 bucks. In this case, we take $700 minus 3 15 and that gives you $385 which you can see on the bottom left hand corner of this craft that little blue number minus 3 85 That's our maximum possible loss on this position. And so, with the maximum profit of 3 15 and the next loss of 385 that basically means you are risking one to make one in this scenario, which is a pretty good risk reward set up in my opinion. And so I believe that wraps this video up and in the last video coming up next, we'll be talking about the calendar spread, which is a very different kind of strategy that is meant to take advantage of volatility in the stock market. So see the next one thanks. 5. Calendar Spread: All right, welcome back to the final video. In this course where we're gonna talk about the calendar spread and this is a bit more of an intricate strategy that is mostly designed. You take advantage from the expansion of implied volatility in the market. And so first, let me discuss briefly what implied volatility is something to the charts here. This is the price action chart of SP Y, which is just E T. F that tracks the S and P 500. Basically the U. S stock market as a whole and implied volatility is indicated right down here this ivy 22 you can interpret this as 22%. That basically means that over the next year we can be reasonably confident that the S and P 500 or in this case, SP Y, is going to move either up or down from where it's currently trading by about 22%. So it s P y currently training about $326 per share one year from now. Like I said, we could be pretty confident that the value of this utf is gonna be up or down by about 22% Now. This number, though this implied volatility number can change all the time. For example, when the carnivores pandemic hit and the U. S stock market had a huge selloff which you can see right here implied volatility, which is represented by this graph down here had a massive expansion. So even though right now it's at 22% during the peak of the coronavirus panic during all this selling actually reached a value of over 85% which is almost four times greater than where it is right now. And so, like I said, the calendar spread is best suited to take advantage of an increase implied volatility. So you would obviously not want to put on a counter spread during this time right here when implied volatility was at the highest because soon after, it quickly contracted back down. But now it has contracted by over four times since the March low is basically and my overall assumption, for example, in the U. S. Stock market is that is way overvalued based on what's happening in the economy and where most companies are currently. And so my assumption is that somewhere in the relatively near future, we could get a pretty significant correction and the market may come back down quite a bit lower. And typically, when the morning comes down fast and hard, that's generally win. Implied volatility expands the most rapidly and thus that would make for a good situation to use a calendar spread. And so the basic construction of a calendar spread, it's actually quite simple. What you're gonna do is we're going to sell either call option or put option. Doesn't matter. Although I do have a preference. Don't talk about that in a minute. So we're gonna sell an option in some expiration cycle, and then we're also going to purchase the same kind of option, right? So if we first sold a put and we're going to buy a put or if we first sold a cold and we're gonna buy a call, but then we're going to buy the same kind of option in a further dated expiration cycle and keep the strikes exactly the same, so as an example, if I go to the trade tab here and pull up the option chain for S. P Y, which looking at again are the calls and puts for the September expiration cycle. And as an example, I may want to first sell this 320 strike put option and then in the October expiration cycle. If I scroll down here, then purchase the same strike. Put Option 3 20 again. But as you just saw in the October expiration cycle, and so the ideal scenario here is, of course, the counter spread as I mentioned profits from the expansion of implied volatility. And that happens most the time when the market actually falls and that fall in the stock, plus the expansion of implied volatility. Both of those things can actually work in our favor to generate profits on this position. So this is why I, General like to do calendar spreads with put options and not call options. The ideal scenario is we want implied volatility to expand, and we went the stock that were buying this link puts on to come close as possible to our actual strikes. So, for example, if we're buying and selling call options and let's say, a couple weeks down the road, the market actually took a nose dive a little bit and implied volatility expanded. But in the process with the market moving further away from our strikes than that would actually work against the expansion of implied volatility. But with put options, if the market does fall, maybe down to 3 21 and our strikes are 3 20 so very close to our strikes are that's certainly going to be a good thing and help generate profits for our position. And then also, we get that expansion implied volatility that's going to generate even more profits. So they go ahead and set this order, all right, so you can see here we're selling one S P Y contract September expiration strike of 3 20 then also the same time buying an SP Y contract. But this time in the October expiration cycle and the same strike 3 20 we were actually paying an overall debit of $340. So this is a debit based strategy. This is not meant to be a credit, and so that means you will not have a very high probability of success. But that does not mean this kind of strategy, right? The calendar spread should be ignored, and that's because in times of low implied volatility, across the board. It's going be very difficult to find opportunities where there's high implied volatility, and that would make it advantageous to be selling options, taking the credit, high probabilities of profit, all that good stuff. And so when there's low implied volatility across the board, thes calendar spreads can be a great way to still stay engaged with the market maker trades that have decent probabilities of making profits. And hopefully, if implied volatility expands, you will obviously make a profit on your calendar spread. And then that would be a good time to start selling options again and taking advantage of those high probability of profit credit based strategies. And so how exactly do these counter spreads actually generate profit when implied volatility expands and also when the stock price moves closer? Twere your strikes are well, as a quick refresher implied volatility is actually one of the major components, like was into pricing an option right? There are other things as well, like the price of the stock time to expiration, interest rates, things like that. But implied volatility is one of the most significant factors in pricing these options, and there is a positive relationship between where implied volatility is in the price of that option. So, for example, when implied volatility expands the price of the options, both the calls and the puts are going to inflate and become more valuable. And then, conversely, went implied volatility, contracts that's going to make the options become cheaper. So just focusing first on the implied volatility component of this calendar strategy if implied volatility does expand. That's what we want that's going to inflate the prices of both of these options that we bought and sold. And so then you might be thinking, Well, if the option we sold increases in price isn't going to work against our position, and that's exactly right, this put option that we sold in the September expiration cycle. We could sell this right now for about 820 something dollars. But if implied volatility expands by maybe 10% the price this contract might jump up to over $1000. The cool thing, however, with this kind of strategy is the price of the option it we bought in this case in the October cycle. The price increase from the increase implied volatility is always gonna be greater then the price increase of the option that we sold in the nearer term expiration cycle. And that's simply because implied volatility affects option prices in further expiration cycles more than it does for options in nearer term expiration cycles. So when implied volatility expands, the price of our short put option here might increase by 5% but the price of the option that we bought in the October cycle might increase by 8%. So in the end net net, we actually will be more profitable on this position, meaning the value of this spread would go from 3 40 We bought it and it might jump up to over $400. So then, if he bought in at 340 were able to sell out of this position at 400 something, obviously we get to walk away with a nice profit. And now, shifting gears and focusing on the second aspect of how these calendars Fred's can generate profit, which is ideally the stock price moving closer to our strikes are if that would happen and SP wire to go from 3 26 where it is now and fall down to maybe 3 21 once again the option that we sold here in the September expiration cycle That's going to work against us. But not as much as the option that we bought is going to work for us in this position, right as SP Wife falls. And keeping in mind that options closer toward this stock prices, cruelly trading, are more valuable. So it's S p Y falls down. It gets closer to our short put option, the price this option is going to increase. But because that's also gonna be happening toe are long option in the October cycle and also keeping in mind that further dated options have more extrinsic value or more time value baked in than nearer term expiration options. That means as S. T. Y falls, the price increase of the October put is going to increase faster than the price increase of our September put. And so, in both of these scenarios, right, the expansion implied volatility and the stock price moving closer to our strikes, and both of scenarios are long put option in October, the price increase of that option is always going to more than compensate the price increase of this September option which is working against us. So let me hop over to the analyzed tab. So once again you can see this in a visual way. And I hope this makes it more clear in that look at this graph and you could CSP wide trading right here. A $326 per share if it were to fall down closer to our strike start at 3 20 According to our path diagram here are profits would increase basically exponentially. And again, this just has to do with our long put option in October increasing in price faster than the price increase of our short put option, which is trying to work against us in the September expiration cycle. Now, one thing to keep in mind is this graph does not account or does not show the additional profit we could make if there was also an increase in implied volatility when S p y, or if SP wife falls down to around 3 20 Obviously this graph for the software cannot predict what implied volatility is going to be in the future. So if SP y or to fall down to around 320 also a company that was a 10% or so increase in implied volatility that would actually boost this graph even further higher. And that would obviously boost our profits as well, Right? This graph right now simply depicts our profit potential if SP y or to simply fall down too much closer to our strikes. But as I mentioned earlier in this video, when the market falls and falls quite rapidly, you almost always see a rapid expansion in implied volatility as well. So even though at the peak right here, right at exactly $320 per share, our maximum profit potential is $518. There was also, let's say, a 10% increase implied volatility are actual Profits may be well over six for $700. And this is, of course, why you cannot at the outset calculate what your maximum profit on a calendar spread it could be. That's because there's no way to predict what implied volatilities gonna be in the future. But your maximum possible loss is always going to be simply the debit that you paid to get into this position. So 340 bucks is simply the maximum amount of money we could lose if we didn't get the implied volatility expansion or the right movement. SP. Why that we wanted right? Let's say SP y, as the weeks and months will buy, continue to just go higher and higher and higher and typically when markets move higher, implied volatility also contracts. And as long as SP Y stays above our strikes at 3 20 eventually, when these expiration dates come, both these options expire worthless. And we simply lose the full $340 that we spent to get into this position. Conversely, let's say as people, I had a massive drop and maybe went from 3 26 down to 280. Looking at the scrap we obviously have missed are profitable zone right here, and we will be back to an unprofitable zone and we'd be down a few 100 bucks Now, Once again, the script is not to pick the very likely significant expansion. Implied volatility of that would come with such a huge drop in the U. S. Stock market. So, in reality, our losses would probably b'more around this area. So maybe minus 100 or 150 bucks and moreover, at a market price of to 69 or to 70. Both of these options would be in the money come expiration, which might sound a bit scary since we have this naked put option that we would then be assigned on September 18th which means we would have to buy 100 shares of SP Y at a price of 3 20 that be a $32,000 purchase. But don't forget, we have this long put option in October that gives us the right to sell 100 shares of SP Wyatt 3 20 And even though it's at a for their expiration date, we, as the owner of the option, could still exercise it early, so that if on September 18th of SP wise below 3 20 we get a sign on this put option, we have to buy 100 shares of 3 20 then we could just early exercise this long put in October and sell them right back into the market at the same price. So in the end net net, we don't lose or make any money on the trade. The only money we ever stand to lose is simply this $340 debit that we paid initially up front to get into this calendar spread. So I hope that all this, or at least most this made sense again. I know this is a bit of an intricate strategy. It could be a bit confusing to understand all this when you are learning for the first time . But bottom line key takeaways are. If you do find yourself in a low, implied volatility environment and your funding and difficult to find good, advantageous situations to be selling options i e. When implied volatilities elevated, then these counter spreads are a great alternative to help keep you engaged in busy during those low implied volatility times and when implied volatility does start to expand again, then hopefully a few counters friends you have on will be profitable. And then you can get right back into gear and start selling options and giving yourself high probabilities of success and a lack good stuff. Just keep in mind. These are not super high probability trades so you don't want to be doing is all the time, although my recommendation is if you do want to give yourself the best chance at making profit on these kinds of strategies is to be doing them with put options because once again , as the market falls and gets closer to your put strikes, that's typically going to be accompanied by an increase in implied volatility. And both those things are gonna work for you in this kind of strategy to generate profits. So with that being said, thank you for watching and I'll see you in the final video coming up next just to wrap things up. 6. Wrapping Up: All right. Congratulations on finishing this course. I really hope you enjoyed it until we get started practicing with the various strategist taught in this course, you can take a look at the course project down below. I do want to say that if you are new to the world of trading, whether that's with options or stock futures for X or all the above, it will take some time, most likely to They're good this stuff out and to become a consistently profitable trader. So as you are learning and practicing with the strategies taught in this course, I would recommend you do so first in a paper trading account basically using fake money because mistakes certainly aren't easy to make. And this profession that can also be quite costly as well. And so that being said, thank you so much for watching this course. I am Scott Reese again doing, trying publish one new course every two weeks. And please do also check out to the courses I have on skill share. I think you're really enjoy them. And also, please, do you follow me on the platform as well, so that you will get notified every time I come out with the new course. So thank you for watching and happy trading