Hello everyone and welcome to Schwab Coaching. My name is Cameron May. I'm a Senior Manager here at Schwab and this is Getting Started with Options. Specifically, this is Lesson 7 in a series of 10 intended lessons that are designed to bring along that new trader of options from knowing nothing about the topic to being comfortable with trading, maybe even options combining different legs of strategies. It should be a really good webcast series. Today, specifically, we're talking about long put spreads. We're starting to combine the individual building blocks of options into more fancy strategies. I'm looking forward to this discussion. We're getting into the bearish side of things today. Before we can get to any of that, though, let me first of all say hello to everybody that's already chatting in out there on YouTube.
Great to see everybody. Hi there, Mighty Mouse and Will and Paul, Sharon, Rick, David, Cedartown, JB52, Henry, Armando, Josh, Kurt, Ted, Lawrence, everybody else. Thanks for joining us week after week. We always do appreciate your attendance and your contributions in these discussions. If you are here for the very first time, I want to welcome you as well. Yes, we are on Lesson 7 in a series of 10, but I'll try to go at a pace that everybody can follow. Make sure I don't leave anybody here in the dust there. Then you can catch up on the other lessons afterward. If you like, I'll show you where to find those. But also, if you're watching on the YouTube archive after the fact, if you're just watching the recording of this presentation, enjoy, but be aware that you're invited to join us in the live discussion.
This is a Tuesday webcast series, and we kick things off promptly at noon Eastern. We'd love to have you here in the live stream. I also want to let everybody know that my very good friend Connie Hill is joining us, the live stream audience here in the chats. Connie's going to be answering any questions that I can't get to just during the flow of the presentation. We're not too far off topic. Connie's there to pick up my slack, so thanks for being there, Connie. And Connie and I would like to issue an invitation to everybody watching. If you're not following us on X, if you have an X account, give us a follow. That's the best place to connect with your favorite presenters in between these live streams.
You can find Connie there at ConnieHillCS, and you can find me on X at CameronMayCS. But let's get into this. Lesson 7, Long Put Spreads. Of course, as we dive in, we first, First of all, need to cover the risks associated with investing and trading. It certainly applies to options as well. So remember that the information here is for general informational purposes only and should not be considered an individualized recommendation or endorsement of any particular security, chart pattern, or investment strategy. Options carry a high level of risk and are not suitable for all investors. While this webcast discusses technical analysis, other approaches, including fundamental analysis, may assert very different views. Investing involves risks. Investing involves risks, including the loss of principal, and any investment decision you make in your self-directed account is solely your responsibility.
Finally, just remember, we are going to be using short options in these combination strategies, and this long spread is going to include short options. So remember that short options can be assigned at any time up to expiration, regardless of the in-the-money amount. All right, so here's where we've been and where we're headed with this series. So six weeks ago, we started with Lesson 1, which was understanding the basic building blocks that all options strategies are constructed from. So we talked about, first of all, long calls or buying calls, then buying puts, then selling calls, then selling puts. Those are the four fundamental building blocks of just about any fancy strategy you've ever heard of. An iron condor, a butterfly, or vertical spreads, which is today's topic.
So last week, we got into building combination strategies, and we started things off with a long call vertical spread. Today, we're going to go in the opposite direction, and we're going to build a long put vertical spread, which is a bearish strategy combining buying puts and selling puts. Now, as we continue our lesson series, we're going to get into two other combination strategies. And finally, in Lesson 10, we'll talk about how a trader might choose among all these strategies. What's a good strategy? What's the process of elimination for just zeroing in on one strategy that seems appropriate for that trader's expectations for markets? So I hope you'll join us for all 10 lessons. But today's lesson, here's the agenda.
We're going to define just exactly what long put vertical spreads are. We're going to discuss potential entry signals, discuss selecting which expiration strike price traders, you know, considerations there. We're going to get into trade management techniques, including managing the back end of the trade with some exit strategies. And we're going to place at least one example trade today. So I want to kick things off with a quick discussion of applied materials. So it's going to be our example trade. This is a spoiler alert. We're going to be building our strategy using applied materials. But before I get into that, of course, naturally, somebody is going to ask, so Cameron, before we even look to put on a long put, what vertical spread, whatever that is at this point, what sorts of stocks might one consider?
And really, the considerations are largely the same as those that we've previously discussed in this webcast series for whether we're doing long calls or long puts or short calls or short puts or a combination of those. There are some considerations that a trader might have top of mind, like the price per share. Also, the liquidity of the stock. Illiquid stocks tend to have illiquid options. It can make them difficult to trade. They can't trade profitably. And that's already a tall enough task as it is. But another consideration is what the chart is doing. Now, the strategy that we're discussing today, this long put vertical spread, is a bearish strategy. So for some traders, after they've qualified price and liquidity concerns, maybe their eyes might go to a chart.
Now, not every trader uses charts in the planning and execution of options trades. But let's just put ourselves in the shoes of a trader who's trying to plan a bearish trade on Applied Materials. And something they might look for is a stock that's been working its way downward. It just appears to be bearish. So the trend, for some, may be important, heading downward. Now, another thing that we might note with the applied materials here is that it seemed to be strengthening that trend over about the last six or eight weeks. And in doing so, it established this upward sloping trend line, which really seemed to be an area of support, or a rising price floor. And just recently, it broke down below that floor. Now, that's one of two technical signals we've discussed in the past.
Breakouts—typically we've talked about bullish breakouts, but in this case, we have a bearish breakout. But also, bounces have been discussed as potential entries. And I'll show more precise examples of those in a little bit more detail later in the webcast. But let's just say that our trader here thinks that stock looks appropriately priced. Let's say that they think it's liquid enough and they see the stock has been in a downward trend, just recently broke through this price floor and they're starting to think, ah, let's do a bearish trade here. Now, we've already learned in lesson two that one bearish option trade that's among the potential considerations for a trader is to go buy a put. Buying a put establishes essentially a locked-in, a contractually guaranteed, a contractually locked-in selling price of a stock.
So let's do that. Let's start to build our example trade today. I'm gonna go right to the trade tab using applied materials as our example. And this is gonna be our example trade. A long put spread. Again, sometimes referred to as a long put vertical spread. We talked about where that terminology comes from last week. If you wanna go back and revisit that archive, you can find it on our Trader Talks channel on YouTube. Just go to YouTube, look for Trader Talks from Schwab. So specifically the full title here is Trader Talks Schwab Coaching Webcast. That's our channel. But you can find our playlist for this series and others right here. And if I were to click on that, we could scroll down; this one is near the bottom, not all the way at the bottom, but you're specifically looking for getting started with options.
And we can just click on that to view the full playlist. Now, another thing I'll do for those that are here in the live audience, let me just copy that playlist link. I'll just copy that, paste it over into the chat window. There we go. There you have it. All right. But getting back to our trade example here, yes, one bearish approach to trading options is to just buy a put. And actually, that is the first half of the strategy that we're discussing today. It starts conceptually with buying a put. So how about we go out here, let's look at our chart and let's say that it's our trader's conviction that looks like our stock has broken down again. This seems to be spurred by possibly a negative reaction to an earnings announcement.
And maybe our trader thinks that's going to set the stage for the coming weeks and months. And at the very least, maybe they expect the stock to remain below that broken price floor, which seems to be around 180. Let's draw in a line right there at 180, just representing that price floor. And let's say that we were go to the 21st of March and we were to buy a put. Let's actually look at maybe a 185 put. We're going to buy here the 21st of March, $ 185 put, and that at the moment is trading between 1565 and 1590. Let's say that we had to spend $15 . 80 for that put. So just to revisit the logic of a long put, when we say long, that just means we're buying something to initiate a trade.
Well, if we were to buy that 185 put, what we're doing here is spending $15 . 80, $15 . 80 per share, or in other words, on a hundred shares, that would be $1 ,580. But for that premium that we're paying, we would then have the right, the contractual right through the 21st of March, or for the next 31 days, we have the right to sell shares for $185 per share. In other words, put those shares into someone else's account, essentially through a contractually enforced sale of shares at 185. So that is a bearish strategy, because as the stock falls further, as long as the stock falls, the potential for profitability grows in this position. If the stock falls to 150 bucks, we don't know where it could drop over the next 31 days.
But if it dropped down to 150, we'd still have the contractual right to sell those shares for 185. Yeah, the further the stock falls, the more the profit, the greater the profit potential for the trade. So that's the sort of motivation for a long put, but just like with the long calls that we talked about last week in the construction of our long call spread, there are some inherent shortcomings, risks to buying puts. Well, one thing that some traders might sort of scoff at initially is, well, Cameron, you're telling me $15. 80 per share, that's $1,580. There can be a significant cost of entry just in entering into a long call. Well, that's a long put trade. Yeah, yeah, there's a cost there.
So maybe that's something that a trader might have back of mind, top of mind maybe, to try to reduce in some way. Now, another thing is time is working against our long put trade right from the start. Because what we've done here is we've locked in a selling price of $185. As a matter of fact, right now, that's about a $13 premium over what we could get for the shares at the moment. So, that's a $13 premium. By spending our $15. 80, we have, you'll notice that stock is trading right now around 172. If we have the right to sell for 185, we now have an advantage over everybody else in the market, basically. We have the right to sell shares for more than they're worth.
But we've paid $15. 80 for a $13 advantage. We need that advantage to grow. And every day that goes by, and the stock hasn't fallen in price, giving us a larger premium above current market, has actually increased our price, how much, what's the good or bad impression as you work the stock market in the deep embankment freight, Tom is working against this trade, yeah. With long options, time is ticking against that trade. So, we have the cost of the trade that might be considered a drawback for just for buying puts. We have time decay, working against that trade. And you add those things together, and actually the probabilities are not in the favor of this trade.
Probabilities, when buying options, those are inherently lower probability trades, meaning less than a 50-50 chance of some profit if we carry this all the way to expiration. BLR says, would the stock have to fall $15 . 80 to break even? Not quite, because it's already $13 below where it would ultimately need to be, right? So in this case, it would need to fall a little bit further, a few dollars further. In other words, we need to be, the stock would need to be $15 . 80 below 185 for a long put to be at a break even level at expiration. Okay? So it's most of the way there, but it's not all the way there yet, so it needs to get on its pony and start riding in that direction.
And if it doesn't, time starts to chip away at this. So here's a solution that some traders strike upon in their efforts to reduce cost, to get time working in the favor of the trade, and to increase the probabilities of the trade, and that is to make this into a vertical spread. So just like with our long call vertical from last week, at the same time we buy an option, we're going to sell an option. Okay. Okay, Ted, yeah, we'd want to include commissions. You're exactly right, Ted. I've kind of, I should put a little asterisk next to my earlier statement. We need to compensate essentially for the cost of the trade plus a little bit, right? The 65 cent premium or 65 cent commission. Good call out there, Ted.
But we're going to buy the 21st of March 185 put. And for this example, we're gonna sell at the same time the 21st of March 180 put. And that looks like that's trading between $11. 45 and $11. 70. Let's be a little bit generous here. Let's say that we're able to sell that for $11. 60. So this creates our spread. And as we discussed last week, there's logic behind the naming of this strategy. It's called a long put vertical spread. Long because net, we're spending some money here. We have $15 and 80 cents that we've spent, but we're collecting $11 and 60 cents from the premium that we're selling. That means net between the two, there is a net debit for this trade.
Also, representing the theoretical max loss of the trade of $15. 80 minus $11. 60. So we're looking at a $20, pardon me, a 420 cost between the trades. So we're looking at $1. 20. So one thing I should point out here is one of the available gadgets on your Thinkorswim platform is a calculator. If you ever need to break this out, $15. 80 minus $11. 60, giving us that calculation there, but $420 is the net cost of this trade. And since there's a debit, it's considered to still be net a long position, buying to enter into a trade. So it's a long position constructed using puts, so a long put, vertical spread. Where does the vertical and spread come from? Well, there's a spread.
The only distinction between our two contracts, they're both for the same stock. They both have the same expiration. The only difference here, they're both puts. The only difference is the prices. So $185 versus $180. So $185, $180, there's a spread in price, a $5 spread between those two prices. And you think of $185 is above $180, it's a vertical spread, long put, vertical spread. All right. So there's our strategy. This is the cost of that trade. Well, how much can this trade make if this is the investment? And that investment is? It is at risk. That's how much we might lose. Well, specifically with this trade, we know when we buy a put, we have the right to sell shares for $185.
We also know from, and we learned this in Lesson 2 in our series, we learned in Lesson 4 of our series that when we sell a put, we have an obligation where someone has the right to sell shares to us entirely on their time frame, at their discretion, any time between now and the expiration of the contract. Someone can require us to buy shares at that price. So if we're required to buy shares at $180, but we also have the right to sell those same shares for $185, ooh, that'd be a $5 profit. The theoretical maximum gain of this trade would be that $5 profit on the stock if the contracts were assigned and exercised. Assigned at $180, we exercise and sell at $185, $5 profit, but it cost us $4.
20 to set this deal up. That would leave us with a $0. 80 gain. Yeah. So, yeah, there's our maximum theoretical gain. And again, just like with our spread from last week, the potential for gain in the way that I've constructed this example is smaller than the potential for loss. And you might think that's terrible. Why would? If this were a coin flip, this would be a terrible deal. It's not a coin flip. Actually, we have a much higher probability of success than failure on this trade. And that's why some traders are totally fine with a lower reward because the reward has a higher probability of being the ultimate outcome of the trade. They're okay with taking the larger risk because, comparatively speaking, there are fewer scenarios where that is the outcome.
Ian says, I learned this technique is a bearish deficit. Debit spread. Exactly, Ian. Yeah, there are all sorts of titles. You don't notice we have lots of names for these things. Is it a debit spread? Yes, because we paid for it. A debit came out of our account. Is it a long spread? Yep, because we spent more on the long position than we received on the short position. Is it a put spread? Yes. Is it a vertical spread? Yes. It's kind of like the way you describe your car. I know it can be confusing to try to, to latch on to all this different terminology for the same thing. Why does one person call it a debit spread? Another person calls it a long, a long put spread.
Another one calls it a long put vertical. Just, just preference. I might describe my car as a, as a 1982 Honda Accord. Someone else might describe it as a, as a sedan. Someone else might describe it as a, as a black four-door. It's all the same thing. Anyway, trading growth says why I applied materials based on PE. It seems a good value stock. Good question. For some traders, they may, they may implement other fundamental requirements. I didn't do it in this exam in, in this scenario. But for some, they may include among their pre-qualifiers for consideration for a bearish or a bullish strategy. How does the stock appear to be? How does the company appear to be? Is it healthy or is it unhealthy? According to, however that trader defines those terms.
So it's, it's a good observation, but not every trader pays attention to fundamentals in the construction of strategies that are going to play out in this case in a month. Typically fundamentals are for a longer term perspective, but not always. Right? Yeah. So could there be other ways for a trader to choose which stock they decide to do a trade on? Of course. Yep. All right. But here's our, here's our vertical spread. There's the potential for a gain. There's a potential for a loss. Let's talk about how these things might be realized and the probability of those things happening. So let's go to our chart and I already have a line drawn in at 180. Let's draw in a second line here at 185, that's going to be right up here, I'm going to take it right to right above the current price.
Let's draw that in right there. So this represents our other, the other, what we'd call the leg, the leg of a spread. Yeah. Each of these, the one that we bought and the one that we sold are called the legs. It's kind of like when you put your pants on, you'd put them on one leg at a time while buying the, buying the long put, selling the short put is like putting on the legs of the trade. So here is our long put here is our short put and where we would prefer to be. This is a bearish strategy. We'd like to be down below. That spread. So I'm going to make this our green box. I just drew in that green box and look at where we are right now.
You can see, I think intuitively why this is a high probability scenario. If the stock needs to be below 180, as we approach that March 21st expiration, we're already there. The stock doesn't actually have to do anything in order to be in a max gain scenario at expiration where we would not like to be. In other words, at the end of this trade is anywhere up here. And I can carry this as high as I want to go. I can carry this as low as I want to go, but let's edit the properties of this. Let's make this our red field. There we go. Yeah, this is our no-fly zone. We don't want to go there. So why is that? Let me get rid of this. No, I'll leave that.
That broken support line in there. Just to make the point for why we entered this trade where we did. But let's work through some scenarios and determine how we'd make our gains, how we make our losses. Let's reverse that, make our gains down here and maybe realize our losses up here. What if the stock continues its bearish momentum and much like most of the rest of the trailing 12 months, the stock goes down as we move toward that March 21st expiration? What if we're down here around 160? Well, if we're at 160 and someone has the right to sell shares to us for 180, are they going to do that? They have an advantage over everybody else in the market. They can sell shares to us at a $20 premium, basically.
Are they going to do it? Yup. You might think, oh no, we got stuck with these shares. They're not worth nearly as much as we had to pay for them. Not time for that. Not time for panic because we also at the same time have the contractual right to sell those same shares to someone else for 185. So if we are put the shares, if we're assigned the shares at 180, well, we just exercise our right to sell those shares for 185 and that's a $5 profit now realized. And whether that happens at expiration or before, that's still theoretically the best outcome for this trade. So, I want to address something just quickly. And that is the concept of the risk of early assignment.
Well, whether one defines it as a risk or not is sort of up to them. But it's interesting when assignment is actually the desired outcome of the trade, is it a negative outcome? No, if we get assigned here at 180, we can exercise, sell to someone else for 185. So if that happens halfway to expiration, all that means is that we accomplished maximum theoretical gain faster. Okay. Josh says, what is the theory on this trade? So that's what we're talking through, Josh. Yep. The theory here, the ultimate hope is for both of these contracts to reach expiration in the money, or in other words, for price to be below our spread, for both contracts to be, both sides to be assigned and exercised. And we, we want to achieve our maximum gain.
That's why if we want to be below our spread, the trader might have a bearish bias on the stock. Okay. So yeah, if the stock goes down, someone sells shares to us for 180, we sell to someone else for 185, $5 gain minus the cost to set this up, leaves us with our 80-cent maximum gain. Well, what if the stock goes sideways? What if it doesn't do much at all? It goes sideways, maybe even ticks upward a little bit. We were hoping it was going to go down. Oh, it went up. Let's say, you know, it's right at 171 right now. What if it goes up to 173 or 175 or whatever, but we're still below 180. If we're at 173, Josh is saying, so this is bearish bias, but positive earnings and guidance.
Oh, I'm not talking about the earnings announcement at all. This is just, um, just the trader's expectation for where price is likely to go in the future. So, you know, we're hoping it's going to go where it wants to go. Obviously, price will go where it wants to go. So we need to, we need to think through, well, what if it does go the way we think it'll go? What if it doesn't, maybe if it just goes sideways or what if it actually rallies up? So if it goes sideways or even starts to move a bit higher, let's say we're up here at 173 and we hit expiration. Someone else has the right to sell our shares for 180. Are they going to do it? Yup.
With very rare exceptions, they're going to say, Cameron, uh, you have to buy my $173 stock for $180. Cause that's what my contract says I can do. And I say, that's fine. They sell me the shares at 180. I sell those shares to someone else for 185. And we still have our maximum theoretical gain of five dollars profit minus the cost to set this trade up giving credit here to Ted. Obviously we have to consider commissions here. I'm setting those aside in this discussion, just as keep it as simple as possible, but can each commission do play a role? You know, instead of making $80 dollars in this case, we need to cut subtract the 65 cent cost on both options to really calculate the max, the, uh, the reward there would actually be $80 minus a buck 30.
Right? John, you say, uh, while I love this stuff, it's hard for me to follow. And that's why John, I think it's so important to just sign sometimes hit the pause button and to think through what is this? Uh, what is this? Uh, we've done. It really all comes down to this, and this is why I break it down into the four building blocks. This whole strategy hinges on understanding what it means to buy a put and understanding what it means to sell a put. If we can wrap our minds around those two elements, the rest of it just flows from that. And if I can understand, if I spent $15. 80 for the right to sell shares for $185, and if I can understand that I received $11.
60 for the obligation to maybe have to buy shares at $180, I can work out the math of everything else just with those basic elements, right? So yeah, sometimes just talk, and that's why I like to talk through each of these scenarios like this. William says, seems like for me, a buy-write is a better way to sell shares. I don't know. I don't know. I don't know. I don't know. I don't know. This one's breaking your mind. Yep. William, what I do want to emphasize, the first time someone's introduced to spread trading, I think just about every, all of our veteran spread traders, and I know some of you out there could give that label to yourself. Was it kind of tough the first time to wrap your mind around this?
Yeah, probably was. But after not too long, it tends to become a little bit second nature. Yeah. But let's talk about what if the stock changed? What if the stock changed? What if the stock changed? What if the stock changed? It doesn't stay down in our max gain territory. What if, despite our best hopes that it was going to be bearish, it turns out to be bullish and the stock really rallies up? It goes up here to 190. Okay. Go back to our basic building blocks. We spent $15. 80. That gave us the right to sell shares to somebody else for 185. But those shares are worth 190. Even though we have a contract that says we could sell those shares for 185, it doesn't mathematically make sense to do that anymore.
So in that case, this is, oh, we just blew our $15,800. Is that a possible outcome? Yep. So that's $15,800. If we get to expiration, that just expires worthless. Ouch. But at the same time, we did collect $11,600. Someone else has the right to sell shares to us for 180. If those shares are worth 180, those shares are worth way more than 180. Are they likely to say, 'Hey, Cameron, out of the kindness of my heart, I'm going to sell those same shares to you for $180?' Probably not. They'll probably say, 'Cameron, keep my $11,600 because they can't demand it back anyway. I'm going to hang on to my shares, my $190 shares.' I'm not going to sell them to you for 180.
So in that case, we keep the 1160, but we blew the 1580. And guess what? We have maximum loss at expiration. So that's what we're going to do. We're going to sell those same shares to you for 180. Why? Yeah, Cedartown says, don't feel bad. I watched this several times. Yeah. Watch it over and over again. Hit the pause button. Let it sink in. And also think about, well, okay, so if this trade is going the wrong direction, maybe it might be time to consider not sitting on our hands and watching us lose the whole 420. Possibly the trader might consider getting out of that contract. Right? If they paid 420 to get it, into it, and it's going the wrong direction, and the value of this transaction is shrinking rather than growing toward five bucks, maybe they want to just sell out of the contract.
William says, so the second part of the spread is your exit strategy. Okay. So William, we just hinted at that. Let's talk about a few potential exits here. But there's one other thing that I wanted to talk about before we get to exits. So we know how much we can make and the circumstances that we're in. So we know how much we can make and the circumstances that we're in. So this is where we might make that. We know how much we can lose, and the circumstances where we might lose that. And again, notice here, the stock has to travel to put us in loss territory. That is a lower probability outcome than just sort of hanging around where it is. If it goes up a bit, we're still in maximum theoretical gain territory.
This is a high probability strategy. And just like we talked about with our long call spreads, what we might do to see what the specific probabilities are is we're going to go to the bottom of the chart. And we're going to go to the bottom of the chart. And we're going to go to the bottom of the chart. And we're going to go to the bottom of the chart. So let's go to our trade tab. Look at our options here. Let's look at our two contracts. And look at delta. Delta gives us the probability, it can tell us the leverage of the trade, the leverage of one leg of a contract, how much we might make or lose as the stock moves up or down a dollar.
But it can also tell us the relative likelihood that the contract will expire in the money, which is the desired outcome here. So what is the likelihood? That we are below 180 and the puts expire in the money, about 67%. There's a 67% probability of maximum theoretical gain on this trade. What's the likelihood that we are instead above 185 and both contracts expire out of the money? Well, according to our delta here, there's a 76% probability that this contract is in the money at expiration. In other words, there's only a 24% probability that we're out of the money. Only a 24% chance of maximum loss, 67% chance of maximum gain. And then obviously price is going to do what it's going to do between now and March 21st.
We'll see which actually happens. Let's see. John. Yeah. Hey, thank you, John. Let's see. Ian says, since you buy and sell the put at the same time, the other side acts as insurance in case you get assigned. Insurance is a loaded term, Ian, but it does provide essentially coverage. The term that we use is the short position is covered by the long. Yeah. All right. So what I did want to talk about before we talk about entry and exit strategies is let's clean things up just a little bit. Let's remove this drawing here. Let's say the stock rallies, but it doesn't go up above our spread. Instead, it winds up in between. So let's say we're at 182 at expiration. Let's talk through.
If we have the right to sell shares for 185 and they're only worth 182, are we going to do it? Yeah, probably just to sign or exercise that contract because we're selling the shares at $3 more than they're worth. Problem here is, if someone has the right to sell shares to us for 180, but those shares are worth 182, are they going to do it? Nope. They're going to say, Cameron, I'm hanging on to my shares. And in that case, we might wind up short shares of stock if we allow this to go to expiration. And you might think, well, then at expiration, I just won't exercise. Actually, at expiration, that decision is taken out of your hands. All-in-the-money contracts are assigned at expiration.
Unless explicit instructions are left in the form of a do not exercise order, all-in-the-money contracts are assigned. So yeah, be aware that this could result in selling shares that we never intended to sell if we allow it to get all the way to expiration and only the one side is exercised. So if we're in between the strikes, what might we want to do before expiration? Maybe consider getting out. Okay. So let's talk about entries and exits, and then we're going to place our trade. So one possible entry that we've discussed, we talked about it today, and we've talked about it in previous webcasts, is when we break a, in this case, a price floor. Anything that might cause a trader to think the stock is going to go down further might be an impetus to do a bearish trade like this.
But in this case, we had a price floor that seemed to be adding some bullishness to the stock. So if we break that floor, might be a signal to some traders, now's the time to take a bearish trade like a long put spread. So that's one potential entry. Another potential entry is what we'd call a bounce. So for example, if we look at applied materials, a bounce for a bearish trade is when stock rallies up, hits a price ceiling, and then starts to ricochet or bounce and go down again. So you'll notice here with AMD, there was a rally up, we have this red candle stuck its little wick up the furthest. And then for some traders, they wait for price to go down and close down below that highest day.
Or for some way to confirm that price is starting to move down again, it may just be when they see an apparent price ceiling, that they start to see red candles appear pushing prices lower. Right? But whether bounces or breakouts or some other signal for entry, that might be when the trader initiates a trade. When might the trader exit the trade? Let's go back to our applied material scenario. And let's talk through three exits and they relate very strongly to our exits for our long call spread from last week. Sometimes the trader exits because the trade has gone so well. And other times the trader exits because the trade has gone so poorly. So let's start with the fun stuff first. Let's say we take this bearish trade, and the stock starts going down.
And what we're looking for is, both of these contracts to just be assigned an exercise at expiration. Well, as long as we're below 180, as we approach expiration, and the further below 180 we go, the more confident we might feel that that's going to be the case, the trader might actually do nothing. Just let these contracts go right to expiration. All in the money contracts are assigned, so there should be rare exceptions to this, assigned and exercised. As long as we're below 180 at expiration, we're going to send out ginger leaves. Now, there is a requirement for a very long term expiration. So as you go into expiration, the short put, assigned. We buy the shares at 180. The long put, exercised. We sell the shares at 185, maximum theoretical gain, realized.
Well, what if the stock starts to misbehave? What if it starts to rally sharply? Well, in that case, if we start, especially for the trader, if we start to maybe break above the resistance that they thought was going to hold price down, they might think that their website is a bad place to buy stock. So they can about going in and putting in a sell order and selling out of this contract, remember we bought to get into it so we'd sell to get out of it and essentially just get out for what we can get. It's probably not going to be four dollars and twenty cents anymore, it might be two dollars and twenty cents, might be less than that, might be a little bit more, but in any case, yeah if the stock is rallying, the trader might decide I don't want to take any more lumps on this, I'm just going to get out.
Or finally, sometimes the stock really moves sharply in the intended direction, and let's say that this stock just starts to fall hard and we think it's going to take us 31 days to make our 80 cents well what if uh we look at this a week from now and our $4. 20 investment um we can now sell out of it for $4.90. So, we're already 70 cents up. The trader might just consider you considering getting out early on that trade, but in any case, um, there are potential entries, there are potential exits. Let's go place our trade. I'm going to go to the trade tab and a place a trade. There are a number of ways to do this.
One quick way to do this if our spread if our strikes are right next to each other in our in our strike column, and these are 180 and 185, they're right next to each other. We can go up to spread single and just change this to vertical, and that just pairs up each strike with the next one, and we can go to the one the pair that we were interested in, 180 and 185, and just click on the ask price. It looks like it's going to cost us less maybe to get into this right now, but I'm going to click on the ask price, and that creates a buy order in my portfolio, it creates a buy order to buy one set of contracts.
It looks like that might be anywhere from you know high threes to low fours. Let's say that we were willing to spend four bucks to get into the trade, we could just enter that price here or we can use The the scroll down here but let's put in a limit order to buy into this for four dollars uh and uh and here the trader might just calculate okay so one contract, one vertical spread is going to be four hundred dollars maybe they're willing to risk more than that two would be eight hundred dollars three would be twelve hundred dollars and so on let's say we wanted to do a three hundred dollars and so on let's say we wanted to do um a couple thousand bucks that we're investing here so that might be five contracts, dial that up to five and as I click confirm and send this is now going to put it in order to buy five of these vertical spreads.
the 180-185 put spread four dollars is the most we're willing to spend here in this example that gives us a two thousand dollar investment and if there's four dollars invested in a trade that went three hundred dollars that gives us a two thousand dollar investment that could turn out to be five dollars of value that leaves one dollar per share on five contracts or 500 shares that's 500 bucks of maximum gain, there are commissions, there Ted Yep, there we are. The 650 commissions are going to increase the cost of this from two thousand dollars to two thousand six hundred and fifty cents in this example, but let's send. This order off, see if we get a fill I don't know, let's pop over to our working orders here and see okay.
We're offering a four dollar debit, the market value is 380 what did we fill for 380? Okay so we were thinking it was going to cost us 420, ultimately wound up costing us 380, so that leaves us with not 80 cents that we can make but a buck 20 spending 380 to set up a deal where we might make five dollars, that leaves a dollar 20 of potential profit. Okay, so hey Chuck, good to have you on board I just saw you checking in there Chuck, great to have you here, but everybody that is um, a second way that trades might that are building. Blocks of trading option strategies might be used to construct some of these fancier strategies, and I know that for a lot of you this is your initial introduction to this concept of combination strategies.
Don't be intimidated, it'll come with time; I wouldn't expect anybody to get it I'm an I'm an expert in spread trading the very first time I was ever exposed to it nope, that's not the way it works. What I would suggest you do if this is your first introduction to spread trading is maybe go to your paper money and start to build one; specifically as you're thinking through how much can this thing make, how much can It's going to lose, break it down into its individual building blocks. What does it mean to buy a long put? What does it mean to sell a short put? What are the rights? What are the obligations? How much have I invested? How much could I lose?
It'll start to make sense to you just need to work through it a couple of times, okay but everybody um thanks for giving me your time today we've accomplished what we set out to do. Just as a quickly to recap our agenda: we've defined long put vertical spreads; we've determined potential entries; we've talked through expirations; um and strikes; we've uh talked about trade management techniques. And also, placed an example trade, Ted certainly welcome. Gina says, 'Do you need a margin account for long vertical spreads? So, vertical spreads can be theoretically done in an IRA, but you do have to have uh have applied for options trading in the in either account, okay! But here's what's coming up next week: we're moving on to lesson eight, building combination spreads, and we're going to talk about how to build a long put and how to build a long put short call spreads.
And looking forward to that time for me to let you go. Just remember, if you haven't yet subscribed to our YouTube channel, make sure that you do that-you can just go down and click. On the subscribe button, it only takes a moment; it doesn't cost anything, and that's where you can find our playlists and join our live streams. Also, follow Connie and me on X; you can follow Connie there at connie hill cs; you can find me on X at cameron may cs. It's the best place to connect with your favorite presenters, and thank you to everybody who's already subscribed to our YouTube channel. We've already dropped a like in the chat window-I can see over 200 people watching; 67 have already clicked on the like button that's always appreciated, it sounds like a pause applause to your presenters, and it gives their webcast a boost.
In the YouTube algorithm, it helps more people learn about things like long call vertical spreads and long put vertical spreads since that's today's topic anyway. I will see you next week for um well we're moving on to uh building short call spreads another good discussion. On board put it in your calendar to join me then. I'll look for you in other webcasts between now and then, I'll also look for you on X but whenever I see you again until that moment arrives, I want to wish the very best of luck, happy trading bye.
