Am I on the right track?

[OzAsh 10]

Can someone tell me what this option play I want to do is called - if anything and will it work?

I have been trading options successfully for a long time just using puts and calls but I want to move up a level or two.

 

Lets say I want to go long XYZ wich is trading at $49.

Normally I would just buy the $45 and $50 calls but now I want to write a put so that the trade is MUCH cheaper.

My holding times are generally from 3 to 20 days so if the option is going to expire within 20 days I buy the next month out. I only want to write front month puts though.

Rather than do a naked put I also want to buy a put at 40 so my risk on the naked put is the difference between the written put and the bought put. Is that correct?

 

Is this a dumb strategy?

If yes, why?

If I can improve it without getting into the complex stuff - how can I do it?

OzAsh

[gmoneygary 10]

The trade you are talking about is called a vertical bull put spread. I don't think it is a dumb strategy, it's my preferred method of doing a directional (long or short) trade. I like it because time is on your side....can get boring but pays off as expiration approaches. The reward/risk ratio probably isn't as high as buying calls but your winning percentage is higher.

 

You can choose your probablity of winning and reward/risk ratio. If you want a 1:1 reward/risk ratio you would sell an at-the-money put and buy a put lower. For a higher probability trade sell a put out of the money and buy a lower put. You can play with different scenarios and pick which works best for you. Options provide a lot of flexibility. ThinkorSwim is excellent for this kind of analysis.