Options spreads can help investors benefit from increases in stocks, especially high volatility ones, without having to pay full price for the equities.
Credit spreads involve the simultaneous purchasing and writing of calls or puts with different strike prices and are often called vertical spreads, explains Ron McCoy, a portfolio manager with online investing company Covestor and founder of Freedom Capital Advisors in Winter Garden, Fla.
Spreads allow investors to profit without having to determine exactly the direction of the stock or the market, especially during periods of consolidation.
"These investments help to quantify risks," he said. "In return for limiting risks, these trades also limit upside. And the maximum risk and reward is known at the time a trade is placed. Since you are in effect selling some premium, it can also help increase one's chances of winning on a particular trade."
Investors who want to profit from moves in the stock market can use credit spreads without having to time the market exactly or anticipate its moves precisely.
With the market's recent climb, if an investor believes that the markets will retrace from today's new highs, he could sell a call spread at the money or slightly above, McCoy said. This trade is only successful if the investor buys one option and sells another simultaneously.
"If not, investors could end up in serious trouble unless they absolutely know what they are doing, and this point can't be stressed enough," he said.
An investor who favors the prospects for a gold bounce and likes Barrick Gold (ABX) for a near-term bounce could purchase a "bull call spread," McCoy said. Barrick Gold was trading at $15.50 on Monday, which means an individual could simultaneously buy the January 2017 $14 calls and sell the January 2017 $16 calls.