so have you ever been up good money on a
trade and wondered whether you should
stay in the trade and try to make more
money risking what you’ve already made
and more or take profits and move on to
another trade
I’m the head options trader on our
trading desk here at SMB Capital in
Manhattan and I can assure you that
every trader on our desk is faced with
this very question constantly in this
video we’re going to give you a
framework within which to make this
critical decision so stick around as I
think it’s going to be important for
your success as a trader long term
[Music] hi I’m Seth Freuberg and I’m the head
trader of SMB capitals options trading
desk SMB capital is a proprietary
trading firm located in midtown
Manhattan and we provide capital for
options and equity traders from all over
the world trading both remotely and in
our offices here in New York City now
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really very valuable ok
so one of the most widely used option
strategies is known as a debit spread
I’ll show you how a debit spread works
in a minute but it’s important to know
that options can be traded on individual
equities but they can also be traded on
stock indexes themselves like the S
500 index most of you probably know the
difference between index and options and
stock options but I’m gonna do an
extremely quick review for those of you
who don’t so just hang in there if you
already know this information this will
be quick and then we’ll jump into the
guts of the lesson okay so with equity
options a call buys you the right to buy
100 shares of a stock at the strike
price of that option any time before the
option expires and a put option entitles
you to sell 100 shares of stock at the
strike price of the foot before that
option expires but there are also index
options which work similarly to equity
options except there’s no such thing as
100 shares of an index like the S&P; 500
so you can’t really buy or sell 100
shares of an index but what you can do
is get paid in cash $100 per point if
the index expires above the strike price
of an index call that you buy or
alternatively you be paid $100 per point
for each point the index drops below the
strike price of your index foot so for
example if the SPX index is trading at
3,000 and you buy the 30 10 call if the
SPX goes to 30 15 you’d receive $500 in
your account if the index closes at
three thousand and ten or lower your
call expires worthless on the other side
of the ledger if you buy a 2985 foot and
the market sells off to 29 75 you’d make
$1,000 but if the market just sold off
to 20
95 or higher the put would expire
worthless so those are the basics of
index options now let’s jump right into
an example of a debit spread that so
you’re gonna understand the lesson we’re
gonna be sharing with you today so on
June 28th the SPX index was trading up
around 29 30
as you can see from the price chart now
let’s suppose that you were bullish on
the SPX index and you felt that by the
end of july the SPX would be trading
over 3,000 that was just your conviction
other traders might have been bearish
but you were bullish for whatever your
reasons were so at that point you could
have entered into what is known as a
debit spread where you’d buy the 2980
SPX call which expires on July 31st and
you would also sell the 2990 July 31
call as you can see from the
illustration you pay $24.50 for the long
call and you’d be able to sell the short
call at 2990 for $20.50 Fernet cost the
four dollars and since a call owner
receives $100 for each point above the
strike price as we mentioned before you
multiply that by $100 so your total cost
for the trade is $400 now let’s break
down the maximum profit and the minimum
loss on this trade so let’s say you were
right a known expiration day the SPX
closed at 3000 let’s break down what
would have happened at that point well
for the 2980 call that you own that
would be in the money by 20 points
because 29 80 is 20 points below 3000 so
the seller of that call would have to
pay you 20 times 100 dollars or $2,000
for the fact that you own that call now
for the 2090 call that you sold well
that’s in the money by 10 points and
that’s money you owe the one who you
sold the call to so you’ll have to pay
him 10 points times 100 dollars per
point or in other words a thousand
dollars now originally you paid $400 for
the debit spread so if you were right
you’d make $600 but here’s what’s
important to realize if SPX went to
4,000 even you still can’t make more
than $600 why because no matter how much
you make on
long call you’ll have to pay out $1,000
less than that for the fact that you
sold that short call like in this
example where you’d make $12,000 on the
long call but have to pay $11,000 on the
short call and your original cost will
always be 400 obviously so the maximum
profit no matter how high SPX goes will
be $600 in fact at any price above 2990
on expiration you’d make your full
profit because at 2990 you’d be 10
points in the money on the call you own
so you’d make $1000 for that but the
2990 call that one would expire
worthless because it only pays off above
2990 and so your profit is simply what
you were paid on the long call less what
you paid for the entire debit spread so
that’s a quick lesson on exactly how
debit spreads work so before we get into
how this trade actually would have
turned out I wanted to mention that
we’re currently running a 2 our free
intensive workshop at the moment we’re
will be teaching you three real-world
option strategies that professional
options traders use including a really
simple but incredibly effective strategy
that some of the greatest investors in
the world like Warren Buffett used all
of the time plus an options trading
strategy that has a statistical 80
percent probability of profit month in
and month out plus an option strategy
that you can employ with the stock that
you like where you’ll make your target
profit whether the stock goes up goes
nowhere or believe it or not even if it
goes down a small percentage you’ll make
your target profits so if those
strategies would be of interest to you
then you should check out the free
options class that we’re currently
running now just go ahead and click the
link that should be appearing now at the
top right corner of your screen that
will open the free registration page in
a new window so don’t worry you won’t
lose this video or you can just head on
over to options class com to register
for this free intensive workshop it’s a
rare opportunity for retail traders and
investors to learn directly from Wall
Street traders but that’s exactly what
you’ll be getting through this free
online workshop so click the link to
sign up now and don’t miss it let’s now
move forward to the final day of this
trade
live 31st minute and you can see at
around 1:00 p.m. on that date the SPX
index is trading at 30 15 well above the
maximum profit level of 2990 that we
just talked about now
the debit spread that we bought for $400
that’s now worth $9.50 let’s look at why
well the 2980 call is trading at 36 55
in the 2990 call is trading at 2705 so
if we wanted to close it right now we’ve
received 36 55 for the 29 80 call and
we’d have to pay 2705 to close that
short call at 2990 so as you can see
from the calculation if you then
subtract the $400 initial cost of the
option your profit would be $550 now
let’s think about that for a minute the
maximum you can possibly make a $600 as
we went through before and you’re up 550
on the trade so if you don’t close the
trade then you’re basically saying for
the 50 extra bucks which is the maximum
I can possibly make additionally on this
trade I’m willing to risk not only the
550 of profit I’ve already made I’m
risking the entire original 400 dollars
that I paid for the trade in the first
place if the market sells off down below
29 80 where neither the 2990 or the 28
980 options will have any value on
expiration day and the debit spread I
bought would expire worthless you see a
professional options trader is always
looking at risk and reward so in this
case originally we were risking the 400
dollar debit for a gain of $600 but now
we’re risking our entire profit of $550
plus our $400 original cost if the
market sells off to below 20 980 and the
maximum additional money we can make is
50 bucks so if you think about it
intelligently your new risk reward is
950 dollars of risk for 50 dollars of
reward that should make it plainly clear
that for the relationship between risk
and reward is no longer valid
and you need to close this trade and
pocket your profits at $550 you’ve
attained 90 percent of your maximum
profit potential which is the point at
which most professional traders would
close this trade and pocket the profits
but this is what would have happened to
a non professional trader you see the
SPX sold off on that final day of
trading and the SPX closed at 29 80 40
so look what happened to the non
professional trader who wasn’t content
with 90 percent of the potential profit
of the trade the long call at 29 80
closed with worth $40 and the short call
had no value but he paid $400 for the
debit spread originally so you have to
subtract that leaving you with the loss
of $360 on the trade
so the professional trader would have
made $550 and the amateur would have
lost $360 a difference of 9:10 between
the two outcomes by trying to squeeze
out another 50 bucks on a trade where
you’re risking it all at that point
which is frankly very weak reasoning
that’s what separates pro traders from
amateurs the pro traders focus on risk
reward relationships all day while
amateurs lose perspective on their
trades and end up in situations like
this so I hope that it’s clear to you
that a professional options trader is
constantly focusing on risk and ending
that risk when the risk reward
relationships are no longer viable like
in this case and incidentally it’s easy
to maintain these disciplines because
you can simply in this case have put in
a good to cancel order to sell the
debits right at $9.50 at the beginning
of the trade right after you paid $400
for it and that order would have failed
at any point after the trade was entered
automatically when the market reaches
that $9 and 50 cent price that’s
actually a good practice to prevent
yourself from getting too greedy and
losing perspective on the risk reward
trade-offs that will change when trading
options if you constantly pay attention
to risk reward relationships you give
yourself an opportunity to turn into a
consistently profitable trader over time
now just to remind you as I said earlier
if you enjoyed this video and learn
something valuable from it and would
like to learn the details of three
real-world option strategies that
professional options traders use all the
time then you should check out the free
options class that we’re currently
running just go ahead and click the link
that should be appearing now at the top
right corner of your screen that will
open the free registration page in a new
window so you won’t lose this video
don’t worry or you can just go ahead and
head on over to options class com to
register for this free intensive
workshop it’s really a rare opportunity
for retail traders and investors to
learn directly from Wall Street traders
but that’s exactly what you’ll be
getting through this free online
workshop so click the link to sign up
now and don’t miss it and if you found
this video helpful don’t forget to press
on the subscribe button because we’re
gonna continue to shoot more and more
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