Lesson Overview

ORCL Put Debit Spread

Back in April ORCL stock saw a fairly large (and quick) move higher as IV dropped. This gave us an opportunity to enter a directional put debit spread anticipating a move lower in the stock.

During this lesson we'll go through our complete step-by-step process for selecting the strategy, contract month, strike prices, break-even points, etc. We'll leave nothing out and give you a 100% look inside our thought process.

More Discussion

Was This Helpful? Add Comments/Questions

  • Kieth Sg

    what is the exist strategy if ORCL continue to increase for this trade?

    • It’s a risk defined small directional trade. There is nothing you can do to hedge this so the best bet is to keep your initial position small from the start.

  • ryan

    I cannot seem to find %IV in TOS, I can only find ImpVolatility, these are different right?

    • It’s a custom code that we add in to do the calculation but you can visually look at ImpVolatility and figure it out that same way.

  • Tom

    Very helpful, thank you for sharing this.

Show Video Transcript +

Tonight I want to go over in-depth, a look at our recent vertical debit spread that we traded in Oracle. What we do here each and every night on the membership side on our blog and if you're viewing this video, you're obviously either a member.

If you're viewing this on YouTube, you're getting this video about 7 to 10 days after it's sent out to just our members but we go over all of our opening trades and all of our closing trades. Now today, we only had 1 new order, and that was this order in Oracle for a debit put spread.

Since we usually have a lot more than one order on any given day, I wanted to take extra time tonight since we have time in the video to go over the details of how we found this trade, how we selected the strikes and how we determined which strategy to trade.

It'll be a mini-video tutorial here on how to choose and trade vertical debit put spreads in the market. The nuts and bolts of the trade are this; we traded a vertical spread for May which is not this first expiration month but the next expiration month out.

We bought the 42 strike puts and then we went and sold the 41 strike puts and the difference between buying the of the 42s and the selling of the 41s was a debit of 49 cents. At the end of the day, we paid about mid-price of the spread which is ideally what we want to do, right?

The width of the strikes, in this case, is a dollar, and for debit spreads, we want to pay about the width of the strikes or about half of the width of the strikes. In this case, 50 cents so we pay just about a penny shy of that and just about exactly mid-price. The penny is close.

That is our actual trade so it's a 50/50 probability trade and we'll go over that a little bit more. It is not one of our high probability trades where it's a credit spread or an iron condor or a strangle or a straddle, but it is a trade that you can make in low volatility environment.

Let's first go over to our strategy guide right here on OptionAlpha.com. Now if you're a member, obviously you get access to this strategy guide. It's something that is so, so simple but so powerful.

It's something that I've wanted to develop for a long time, and a couple of months ago, I've started putting the action into place and again, it's so simple, but the simplicity of it can't be underestimated as to how powerful it is for choosing the right strategy.

As always, what you do on the strategy guide is you do one, or you do all three steps right in order. The first thing we want to do is make a directional assumption on a stock, and again it doesn't matter what your directional assumption is.

Are you bullish, bearish, neutral, whatever the case is, no bearing on what strategy you choose at the end of the day? Just pick something. Are you bullish, bearish, or neutral? In Oracle, we'll show you guys the chart here in a little bit, but we are bearish in Oracle, just because of the chart's setup, again it doesn't matter.

The next thing you want to do is you want to choose where implied volatility is or find out where implied volatility is. Is it above or below the 50th percentile, so we did a very long tutorial on that last night where we talked about implied volatility in Tesla and some other stocks as well, and this is the key ingredient to this whole business of choosing which option strategy to trade.

You've got to find out where implied volatility is. Is it above the 50th percentile or below. If it's above the 50th percentile, meaning the implied volatility is higher than it is, then you want to focus on options strategies that take advantage of selling options.

We've already laid that out below, and I'll show you guys that. Now if it's below the 50th percentile, you want to take advantage of option strategies that are net-buyers of options.

Again, we've laid that out below; it's very easy to understand. Once you know exactly where implied volatility is, actually the final step is just choosing your strategy, so we've laid out some of the top strategies that we used there's obviously a ton of strategies, but we focus on the ones that we use and implement right here at OptionAlpha.com and have for years.

Those are the strategies that we've laid out below, so the first step is a directional assumption, the next is implied volatility, and the third is to choose your strategy. If we scroll down, you see how easy we've made it here.

We already just showed you "Okay, this is the column where you choose directions." In this case, if you're bullish, and IV rank is high, then you choose one of these three strategies.

If you're bullish and the IV rank is low, then you choose one of these three strategies, and you can quickly click through all of those strategies and see how they set up and what their risk/reward is, time erosion, break-even price, etc.

We're going to scroll all the way down, past bullish and past neutral directional assumption and we're going to go here to bearish. We're bearish on the market. Now because implied volatility is not high in Oracle right now, we are not going to use any of these strategies here on the left.

We're not going to use the cred-spread, we're not going to use a short call, and we're not going to use the butterfly. We're just not going taking advantage of the right positioning for implied volatility for an option strain.

Instead, what we're going to do is, we're going to focus on these three here which are a calendar, our debit spread, and our back-spread. Now, in this case, we could've traded the calendar for sure.

We could've traded the calendar; we could've traded the back-spread, or whatever the case but in this case, we chose to go with the debit put-spread. Right below, it shows you exactly how we set up this trade, so we're going to buy 1 put and then we're going to sell 1 put at a lower strike.

Right but at the end of the day, that doesn't help, and it's hard for me to put in here exact parameters for every single possible outcome. Instead of doing that, we go over this, and we use these video tutorials that you're watching now as a guideline for how to make those trades and select the strikes.

If you already know that we're going to buy a debit put-spread because we're bearish on Oracle and because implied volatility is low, then what we do is we just head on over to the charts of Oracle so you guys can see exactly what we're talking about here.

Now that we're at the charts of Oracle, you can obviously see why we're bearish on Oracle. We've had some days that have been just high, high, high, high, high. Just moving continuously higher and it's almost gone parabolic here, kind of after earnings.

That doesn't mean it can't continue obviously but historically, you look back, and you see some of the same types of parabolic moves in Oracle, and you see that the stock actually either stopped or declined after moving that far so this is much further than it usually moves.

You'll notice that today we had almost a big shooting star candle pattern up here where the actual high of the day was much, much higher than the stock actually closed.

It's still closed up high and above the open, but it retreated from the highs at the end of the day. That's the only reason that we're directionally bearish, right?

Again, if you're bullish, it doesn't change anything, it just changes the strategy that you trade or the direction of the strategy. The reason that implied volatility is low is that we look up in the top left-hand corner and you can see that the IV rank is at 41.

This doesn't mean that Oracle has 41 percent implied volatility, what this means is that, 60 percent of the time over the last year, implied volatility has been higher than it is right now.

That tells us that we are not going to be net-sellers of options. Instead, we're going to be net-buyers of options, and that's why we're trading the vertical debit spread in Oracle.

If I go to the trade tab, we can break out this trade here so I can show you guys exactly where we're trading this and again, the idea with these debit vertical spreads is that we want to make it a 50/50 probability bet.

We're not trying to make a high probability bet; this is just a position that we want to use to make a directional assumption of the market and be fairly conservative in risk management and how much capital we're allocating.

Now, you'll notice down here in the bottom, as always, we have all of our positions so you can clearly see this is a live position that goes out. All of these positions that we talk about are actual live fills that get executed

We're trading the May contracts which have about 45 days to go in expiration, so that's about where we want to target some things for these debit spreads. April is a little bit too close in right now at 17 days.

Just doesn't give us enough time and May gives us plenty of time to make a directional trade in Oracle for this thing to go the right way. Now, you'll notice in the bottom right-hand corner of the screen where our positions are so you'll see that our first strike, where we bought, is indicated by the green tab and that is the 42 strike puts.

We bought those and then we sold the 41 strike puts to help finance a part of the purchase of the 42 puts. At the end of the day, you'll look down here in the bottom, and you'll see the actual prices that we paid vs. different than where the market ended up at the day.

We paid $1.48 for the 42 puts, so we bought those for $1.48 and then we took in a credit of 99 dollars for the 41 puts. The difference between those is our 49 dollar debit that we paid.

You'll notice that this is a probability of 50/50 probability trade because you'll see that the mid-price around these right now is 41/50. That is the break-even price that we have which is almost exactly where the market traded at the end of the day and where it closed.

If we know that the markets are 100 percent efficient and that stocks truly have a 50/50 chance of going either up or down, then this trade puts our break even point right in the middle.

What we like to do with these debit spreads is we like to straddle the market, don't confuse this with a straddle but we like to straddle the price of the underlined security.

In this case, the price was 41/50, so we traded an option on either side so that our break-even price is as close to that market price as physically possible. It doesn't always get down to the penny, and in fact, in this case, it's the same price as it is right now.

It doesn't always happen like that, but that's ideally what you're shooting for. You're shooting for a break-even price which is matching Oracle's current price, and that'd get you a true 50/50 probability bet.

Last thing I wanted to take a look at here is the analyze tab. I know everyone loves, loves, loves the analyze tab. You'll see that this analyze tab matches up the same as our debit spread profit loss diagram that we have on the website so you can see this is exactly what it is and here is our profit loss diagram.

This is exactly what it looks like at expiration. If we go back to the analyze tab on Think or Swim, you'll notice that the profit loss line here in red matches up exactly to that same profit loss line that we have on our Option Alpha platform.

This is truly why this tool was developed, this ultimate strategy guide that quickly enables you guys to choose the right strategies and put them into use.

Even if you don't have access to the analyze tab here on Think or Swim or your broker doesn't have it, whatever the case is, this allows you to quickly choose the right strategy for the right situation in every market's up so that you're never left deciding which strategy to trade.

You'll notice here on Oracle trade that the current price of Oracle's designated by this dotted line which is right down the middle of the screen so this is where Oracle closed at the end of the day and that's 41/49.

Now you'll see that crosses the zero barriers almost exactly right where our stock price is on our trade price. You can see that this is truly a 50/50 bet. If Oracle trades lower than this, then we're obviously going to make some good money.

If it trades higher than this, then we'll lose almost the same as we could make. Remember, this is a 50/50 probability bet, but it is a directional trade on the market.

All we're betting is that at some point in the future, we're going to have an opportunity to take profits on this and again, just looking at the stock chart, I think that that's a pretty good analysis that we could take some profit on this in the next couple days as people start to unwind this position.

They clearly started to unwind it at 42 today which is high, and so all we would need to see is it moved down to 41 or even 40/50, and we'd see a nice, nice, nice return on our investment for this position.

I hope this was a helpful video to go over the trade that we made here in Oracle today. Again, I know we don't get an opportunity to go over each and every trade as in-depth and as detailed as this but we do have a lot of video tutorials on our website, especially for members.

In the member's section, they go over different strategies in detail, but again, hopefully, this was a great video tutorial for how to trade debit vertical put-spreads in the market.

If you like this video, please share it on social networks, add a comment right below to this video, I'll get back to all of those comments tonight or tomorrow before the market open and happy trading.

eBook Download

The "Ultimate" Options Guide

Ultimate Options Strategy Guide

The step-by-step guide on how to set up each of the top 18+ options strategies we trade to generate monthly income. Read the whole strategy guide in less than 30 mins and have it forever to reference.

Download PDF

Join More Than 47,345 Members

Membership is always free & you can upgrade anytime to unlock our live trades.