Friday, September 16, 2011

NFLX bull put spreads options got hammered yesterday

Recently I came across with an option trading strategy named "Vertical Bull and Bear Credit Spreads". The credit spreads would look like this.: I would start with a position in buying and selling the same underline equity options with two different strike prices and same expiration date. By doing this, I created the spread positions. The positions would be either Call or Put but both would be on the same side.  If the price I receive on the sell option is more than the cost that I pay for the buy option, I immediately receive credit in my account. I would profit from this credit if both options expire after the expiration date. This is one of the method I just learned in using options to generate steady income.

I picked up a few stocks such as AMZN, APPL, IBM and NFLX last Friday and paper traded with the Bull Put Spreads hoping the general markets would go up this week. (Bull Put Spreads: Sell a put with near closing striking price and buy a put with lower striking price and receive credits from the difference in prices from these two options).

Everything was going well towards the market open yesterday. Howerver, the positions I established on 9/9 for NFLX was to Sell 10 Puts NFLX 175 at $.66 expires on 9/16, then I bought 10 Puts NFLX 170 at .45 expires on the same date. The stock was trading at $208.53 at the time and I received a credit of $0.21 which was equivalent of $210 ($0.21 x 1000 shares) before commission. I had about 16% cushion on this (208 - 175)/208 = 16% and I thought I would be fine with 1 week left that it will expire on 9/16 (today). Sure enough NFLX was down about $33 before the market open with "bad bad news" yesterday and continued trading in that range during the day and closed at $169.25. So basically I would lose the $5 delta per share in this spreads position if the closing price of NFLX remained under $170 today. It would translate to a $5000 lost ($5 x 10000) . By trying to make $210 and lose $5000 - $210 = $4790, this is a risky business. Well, fortunately this was still a paper trade and I will continue to study more in this area.

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