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Greetings Traders, welcome to this week's chart lesson!

Today we are going to discuss an option strategy that is very popular and an affective alternative to trading futures contracts. The option position is called the In-The-Money Debit Spread.

The in-the-money debit spread is a very simple option position that has many advantages over straight futures contract trades. The in-the-money debit spread consists of purchasing an in-the-money option and selling an out-of-the-money option of the same expiration month.

It is a position that requires us to pay a premium - the cost difference between the option we purchase and the one we sell in exchange for the possibility of making the point difference between the two strike prices as our profit.

The first and probably the most important advantage is limitation of risk. While an open futures contract burdens the trader with unlimited risk, the risk of the in-the-money debit spread is absolutely limited to the cost of the spread...you can't lose more than that! This can be a more substantial benefit than most traders realize. 

Even though many traders feel that they can limit their risk by using "stops" what is not taken into account is that many times they can be stopped out because of the risks of taking large loss in a market that has begun to make a big move against the position only to see the market reverse and move in their favor. With the in-the-money debit spread the trader knows that not only is his risk limited to the cost of the spread, he is actually hedging some of his losses by the gains on the option he sold.

These factors can be very important especially to a trader who finds that although his ability to predict the market's direction is good, he is emotionally and financially unable to handle the market "noise" of corrections even when the market is trading in his favor. This psychological advantage of knowing that your losses are limited can make the difference in a winning or losing trade.

The second advantage to this position is being able to take advantage of disparity between option strike prices. This can be a very substantial benefit! And, the position doesn't require any margin above the cost of commissions.

The advantages of this position makes one wonder why more traders don't use it rather than trading a market with futures. Still, there are some disadvantages one should consider before they initiate this position. First, we are initiating two positions instead of one so there will be another commission. Second, we are limiting our gains to the point difference between the strike prices. Third, orders should be placed using specific "limit orders" to avoid slippage in less liquid markets.

However, I feel that these disadvantages are a small price to pay between a profitable and unprofitable trade.

Let's take a look at a real-time example of how to apply the in-the-money Debit Spread.

Let's say you are watching the 1-2-3 bottom formation in silver and you would like to trade it because you know it's a reliable formation. Your futures contract signal is generated when "if" prices trade above the #2 point (1195.50) and your stops go below the #1 or #3 points. 

The Margin requirements for one futures contract of silver is about $8,285.00 total and the amount of risk is the distance between the #2 and #3 points which is $5,755.00. Not bad if you're trading with a $50,000 trading account size. But, this trade would be out of reach for small trading accounts.

What if you used the same trading signal of buying when prices trade above the #2 point at 1195.50 but this time look to purchase the in-the-money March Silver 1175 call option for $1,500 and sell the out-of-the-money 1300 March Silver Call option for $900. The spread cost is $600. Your maximum profit potential is the difference between the strike prices which is $6,250.00 

That's well within reach of most trading accounts. To close this trade for profit simply wait until silver prices reach or go beyond the 1300 call you sold and simply reverse your order by selling the 1175 call and buying back the 1300 call. You may or may not get the full profit potential before both options expire in-the-money but it will be near that because you started out with an in-the-money call which is always worth more than the higher strike price out-of-the-money call you sold.

This option position allows even the small account trader to participate in markets where they could not trading futures. It's incredibly easy to do this position and you are never at risk of loss above what you initially paid for the spread plus commissions. 

Traders who don't incorporate the use options in their trading plan are limiting their trading opportunities and taking on unnecessary risks. 

So don't sit on the sidelines because of a lack of knowledge, use options. There are more strategies I would like to teach you and my VTU Lifetime Membership course will show you trading plans and styles that fit any size trading account to get you into the game and off the sidelines.

Happy Trading,

Archie

P.S. Don't forget, the VTU Lifetime course membership includes all three courses, Chart Watch and includes all future courses and subscription services for ONE LOW PRICE. Click here to see everything that's included.

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For more detailed reports and specific trade recommendations consider our VTU Lifetime Membership which includes three study courses, Trend Tracker Charts, and Options and Futures Trade Alerts in Chart Watch. 

NOTICE: The VTU Lifetime Membership saves you over $1,200.00 and an unlimited amount of future expenses for our courses and subscriptions. It is no wonder that nearly every new member signs up for the lifetime course member option because it gives you every VTU course and subscription service for one low price, and me as your personal mentor for as long as you need me! But I can only work with a limited number of new lifetime members at one time to provide the level of coaching support I provide. With that being said, the Lifetime Membership will expire soon and without notice. Most new traders are going along great by themselves after several months of coaching, so if the lifetime membership is not available it will be brought back later in 2007-2008. 

If you have any questions at all about any of the chart lessons, or any other questions, please feel free to write me at: Email Us   or chat with me live if I'm online via our chat button.

Hello Archie,  Your option trading system really works! I traded May 2005 coffee options. I purchased (4) 800 May call options on 11/01/04 for $1,800.00 when the futures was in a sideways channel and implied volatility was 30.1% like you teach. I sold them on 3/11/05 and they were worth $20,238.00 each! My small $5,000 trading account is now near $80,000! I can't thank you enough for all you do!   John Weaver $80,000.00 profits in four months

 

 

"The first time I traded options I could hardly believe it. My money tripled in less than 3 weeks." Cynthia Tennison

 

"I just finished checking my list of purchases. 5 out of 6 are up; one of them has nearly tripled: July Corn. I am up a total of $9,995.25." Linda Caluete

You'll be placing trades like these mentioned here today in no time flat, I guarantee it!

If you are a new trader, or a not yet successful trader trading with $2,500 or less, you should learn low-risk trading strategies or you may not be trading very long. I'll show them to you and provide you with 100% full support from me to help you when you need me!