Here’s how an options spread looks when done right

One of our down gapper
call credit spread setups has been an easy trade to watch.
It has
made a quick profit. Let’s take a look. The stock, Ultratech, Inc. (UTEK), is a
maker of laser systems for the manufacturing of semiconductors. It sank after a
downgrade by Merrill Lynch downgrade, which is how we identified conditions for
a trade.

We took a position in a November 20 call
(selling) x 22.5 call (buying), which formed a call credit spread. We took in a
net credit of $50 in premium per spread following the gap open. The profit/loss
parameters can be seen in Figure 2. Immediate movement lower (the ideal
scenario), or sideways to moderately higher movement, are all conditions for
potentially profiting.

Also known as a bear call spread, the stock immediately declined further, as
seen in Figure 3, which helped the trade show a profit even before time value
decay could lend a hand.

Figure 1 shows the gap open at 18.00, from a previous close right near 21, which
gave us a nice set up to establish a vertical call credit spread

Figure 1 — Generated by OptionVue 5 Options Analysis Software

Figure 2 — Generated by OptionVue 5 Options Analysis Software

Once the stock price moved lower, this November credit spread began getting hit
by time value decay. So the initially position delta short position has picked
up gains from two dimensions, delta and theta. Delta being negative, we gained
from the price declines. And theta being positive, we gained from time value
decay. Currently the spread is showing a profit of $40 (ask is 15 cents, bid is
5 cents). Recall that the maximum profit on this trade is $50, so we have
achieved 80% of the available potential profit.

Figure 3 — Generated by OptionVue 5 Options Analysis Software

In terms of percentage return on this trade, we would need to divide $40 by the
required margin ($225), which gives us a value of +17.8% profit rate. Since
there is more than a month still remaining until expiration, it does not make
sense to hold this trade open for just $10 extra in profit. The money would be
better put to use in a new trade.

Next week, I will follow-up a not so favorable trade outcome which, while
profitable, has had a more difficult time. In the meantime, if there are any new
setups on the radar screen I will be letting you know.

Have a great weekend!

John Summa

John F. Summa is Founder and President of
, and a registered
Commodity Trading Advisor (CTA) with the National Futures Association (NFA).
Founded in 1998, offers trading seminars and tutorials to
options traders, futures and option trading advisories and managed futures and
options CTA account services.

Mr Summa’s trading articles have appeared in
Technical Analysis of Stocks & Commodities magazine, as well as Active Trader
Magazine, Options Trader Magazine, Futures Magazine, Stock, Futures & Options
Magazine, and He coauthored

Options on Futures: New Trading
Strategies and Options on Futures Workbook

(John Wiley & Sons, 2001) and more recently wrote the groundbreaking book,

Trading Against The Crowd: Profiting
From Fear and Greed in Stock, Futures and Options Markets

(John Wiley & Sons, 2004), which includes Mr. Summa’s innovative quantitative
bear and bull news-flow Contrarian indicator.

Mr. Summa is
a PhD-trained economist and operates a delta-neutral
options trading CTA program.

Click here for
information about my upcoming options spread seminar.