There is a fifty-fifty chance of making money if you buy a stock. It might go up or it might go down. Trading options, on the other hand, can reduce your cost basis and, if you trade small and trade often, you can be correct 60% of the time or better! As a result, if you can structure your portfolio and build your trading plan such that you are correct 60-70% of the time, you can steadily grow your portfolio on monthly basis.
Options spreads are an important part of what we do. Although spreads limit your upside, their limited risks help to withstand short-term volatility in the market. Spreads are simple to learn and can be executed over and over again on a monthly basis to generate a monthly income. Spreads work well with Tradespoon tools like Stock Forecast and Probability Calculator, without having to be 100% accurate on predicting direction.
Tradespoon technology works best by selecting 50 to 75 days until expiration, so you have to ascertain the Option Expiration Month. If this is a tad confusing now, don’t worry, we cover the details of picking expiration months in subsequent chapters. Also, it is important to learn Volatility Ranking and how options behave, as implied volatility changes before the earning season and after the earning season. This too is covered in our discussion of Advanced Options Strategies.
Since you are improving your Probability of Success by 60-80%, it is very important to trade small and trade often to make sure that you do not sustain substantial losses when there is a market sell-off or short-term volatility. The concept of Maximum Draw-Down, which is basically how much you can tolerate losing at once, is important in this context.
Spreads are limited risk/reward positions. For instance, Figure 2B shows a risk graph for a strategy known as a Call Spread (covered in Chapter 13). The profit and loss along the y-axis and price of stocks along x-axis. The maximum loss is at point A and maximum gain is at point B. The Breakeven point is where the x-axis of profit and loss intercepts the blue line.
In a bull call spread, when the stock price goes up, you are making more profit and vice versa. We will see in Section II on Advanced Strategies that different spreads have different sloping risk graphs. Bull call spread is one we use quite often.