How to create bullish option spread?

Jerry, my newsletter subscriber, asked me the following question: I like (The Walt Disney Company) DIS long term, say out to 2016. How do I set up a bull spread on it?”

I liked his idea and the company, so I decided to post my answer how I would set up a bullish spread against this company and make money. The Disney Company pays dividends (1.20% yield) and if you do not have enough money invested in this company, spreads can help you to receive even more money for less, which you can invest back into this company and buy more shares.

And you can do it with even less risk than owning the stock!

So how do you create a spread?

It depends on your outlook and what you expect from DIS over time. First, you need to find out what spread you want – debit spread or credit spread?

How to create a debit spread?

If you want to go with a debit spread, for such a long outlook or time span of the trade we need to estimate where the stock can get by, let’s say, January 2016. If we project the trend until 2016 we can see that the stock may reach a level around $110 if it continues in the current trend and growth. See picture bellow:

Disney (DIS)

Click on the picture above to enlarge it

However, we want to be slightly conservative and select trend slope not that steep. We would go with a median growth and then our target price would be around $100. We would construct the debit spread around this price:

BTO 1 DIS Jan 16 100 call
STO 1 DIS Jan 16 105 call
@ 1.53 LIMIT GTC (debit)
Max gain: $347.00 (226.80%)
Max loss: $153.00
Margin: $162

Then you have to wait for the stock to get to your target. The stock must end above $105 in order to gain full profit. This trade starts to be profitable when the stock moves above $93.86 per share if closed prior to expiration and if it gets above 101.54 or higher at expiration.

How to create a credit spread?

If however you want a credit spread (receive money now) then you would have to open bull put spread:

BTO 1 DIS Jan 16 100 put
STO 1 DIS Jan 16 105 put
@ 3.45 LIMIT GTC (credit)
Max gain: 345.00 (222.58%)
Max loss: $155.00
Margin: $164.50

The stock must grow up above $105 to make full profit. The only risk I see here is that we will be selling ITM (in the money) options and since these are American style options there is a risk of early assignment (unlikely) which can ruin the trade. For this reason I would prefer a debit trade.

I think this is not a bad trade idea and I may open one myself. I like shorter trades however, so I will be looking for a shorter expiration term than January 2016.

Hope this helped you to understand how I create spreads or trades. If you have any question, you can always contact me.

And if you want to see what trades I am about to open every week, subscribe to my options alert newsletter. It is free until the end of 2017 and you can follow the trades I post or mirror them in your own account.

Happy Trading and good luck.

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