Now more about the NTES trade I made a couple days ago:
I initiated a bear call because of the poor earnings report. I opened 5 Aug short calls at the $42 strike for a credit of $1.07 because it is my expectation that the stock will remain at or below $42 up through August expiration, which will be August 21. At that point the short call will expire and I will have earned my maximum reward.
I had also opened up 5 Aug Long calls at the $47 strike price for a cost of $0.12. The short option and the long option together form a spread trade. This reduces risk. Had I only shorted the Aug $42 call, I would have an unlimited risk potential to the upside. If NTES jumped up to 50, 70, or 100 dollars, with just a short option open, I would be obligated to cover my short position however many dollars the stock has risen above the strike price of $42. A short option alone has unlimited risk potential.
By adding the long call, it protects me from having the stock gap up.
My reward for this trade would be the credit of the short options minus the debit of the long option; $0.95. The risk would be the difference in the strike prices minus the credit, $5.00 - 0.95 = $4.05.
This means, if the stock stays at or below $42, which is my expectation, all the options will expire worthless, and I will have made $0.95. If the stock jumps up, which is not my expectation, the most that will be at risk is $4.05.
If the stock stays below $42 dollars and the options expire worthless, the 5 contracts at $0.95 would add: $0.95 x 5 x 100 = $475 (minus broker commissions) of value to my account.
If the stock goes above $42 I will adjust the trade by rolling the options up and out for a profit.
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