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  • Added for You - Vertical Spreads - An Imaginary Spread Scenario

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    following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven po
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    Let's put together what we've been talking about, develop an
    imaginary spread scenario and set it in real life events.

    In October, let’s say that you begin to hear about IJK stock. It
    looks interesting, so you then use a variety of sources to learn
    about IJK: news, charts, outside analysts, internet research
    etc. From your investigations you decide that this stock is
    poised for a strong upward move and you'd like to take advantage
    of it.

    However, each share is $50.00 and you question whether you want
    to put out the capital for enough shares to make the trade
    worthwhile.

    Now is the time to investigate IJK spreads. Since you are
    bullish on the stock, you investigate the bullish plays of the
    call spreads and the put spreads. You check the pricing of both
    since you are aware that implied volatility and time decay will
    affect both your purchase price and your selling price if you
    decide to sell out the spread before expiration.

    Let’s say that you set the spread's maximum potential gain at
    $10.00 using our formula. Then you decide you want to buy a call
    spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60
    calls. The spread is called Nov. 50-60. The spread's cost is
    $3.50, which means you pay $3500 for the trade, inexpensive when
    you consider that to purchase 1000 shares of IJK stock would
    have cost you $50,000!
    Now, you wait and follow the stock price of IJK. If you hold the
    position to expiration, you face the following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven po
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    is
    poised for a strong upward move and you'd like to take advantage
    of it.

    However, each share is $50.00 and you question whether you want
    to put out the capital for enough shares to make the trade
    worthwhile.

    Now is the time to investigate IJK spreads. Since you are
    bullish on the stock, you investigate the bullish plays of the
    call spreads and the put spreads. You check the pricing of both
    since you are aware that implied volatility and time decay will
    affect both your purchase price and your selling price if you
    decide to sell out the spread before expiration.

    Let’s say that you set the spread's maximum potential gain at
    $10.00 using our formula. Then you decide you want to buy a call
    spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60
    calls. The spread is called Nov. 50-60. The spread's cost is
    $3.50, which means you pay $3500 for the trade, inexpensive when
    you consider that to purchase 1000 shares of IJK stock would
    have cost you $50,000!
    Now, you wait and follow the stock price of IJK. If you hold the
    position to expiration, you face the following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven po
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    and the put spreads. You check the pricing of both
    since you are aware that implied volatility and time decay will
    affect both your purchase price and your selling price if you
    decide to sell out the spread before expiration.

    Let’s say that you set the spread's maximum potential gain at
    $10.00 using our formula. Then you decide you want to buy a call
    spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60
    calls. The spread is called Nov. 50-60. The spread's cost is
    $3.50, which means you pay $3500 for the trade, inexpensive when
    you consider that to purchase 1000 shares of IJK stock would
    have cost you $50,000!
    Now, you wait and follow the stock price of IJK. If you hold the
    position to expiration, you face the following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven po
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    so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60
    calls. The spread is called Nov. 50-60. The spread's cost is
    $3.50, which means you pay $3500 for the trade, inexpensive when
    you consider that to purchase 1000 shares of IJK stock would
    have cost you $50,000!
    Now, you wait and follow the stock price of IJK. If you hold the
    position to expiration, you face the following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven po
    Chiming the Crime of Lost Time
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    following losses or gains.

    First, if the stock does not move up as you expected and stays
    at $50 or decreases in value, your spread is worthless and you
    lose the $3500 that you paid for the spread. Second, if the
    stock begins to move up, you first recoup your investment and
    then move into profits. After the stock has moved up $3.50 you
    are at the breakeven point. Every money advance after that
    represents profit.

    The chart below represents the spread's losses and gains and
    your total profit

    This chart is based on stock prices at expiration Friday in
    November. Until then the spread's value fluctuates between $0
    and its maximum (the difference between strike prices) of $10.00

    At any time until expiration, you can sell out of the spread but
    what you receive for the price may be influenced by implied
    volatility and time decay and that will change your profit or
    loss. If you hold the spread until expiration and your bullish
    lean proves true, your maximum profit on your $3500 investment
    is $6500.

    You paid $3500 for the spread and received $10,000 at expiration
    with the stock at $60.00. That represents a $6500 profit which
    is a 186% return.

    If you had invested $50,000 for 1000 shares of IJK and at
    expiration sold the stock for $60,000, your profit is $10,000
    for a 20% return.

    For many investors the reward/risk scenario of the spread is
    attractive because investors can limit the capital at risk and
    the time of risk/reward exposure. The spread also offers
    protection if your lean is bullish or bearish. Finally, the
    spread has the potential of a large percentage return on
    investment.

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