What is a Bullet Trade
A bullet trade is a secondary market trade that involves the act of purchasing an in the money option on a security so that the option buyer can capitalize effectively without waiting for a price change.
BREAKING DOWN Bullet Trade
A bullet trade centers around buying an in the money option on a security for profits. This is a strategy commonly used by investors that wish to speculate on price changes. For technical analysts bullet trades can support trading at resistance and support levels. There may be several scenarios where a bullet trade would occur. The concept of a bullet trade is based on the availability of immediate profits. The two most common include buying an in the money put option or an in the money call option. All option trades require access to derivative trading through a broker or brokerage platform.
In the Money Put Option
To execute this trade an investor buys a put option that is in the money. The put option gives the investor the option to sell a specified security. Put options come with many terms. Put options will have a specified exercise price also known as a strike price. There is a cost associated with buying a put option through a broker. Put options are not required to be exercised which puts the upfront cost at risk. They also come with a specified timeframe for execution.
Buying an in the money put option is the key to a bullet trade’s profit. An in the money put option refers to a put option with a strike price that is higher than the market’s current price for the security. Technically the strike price must be higher than the market price plus the option’s cost. This allows the put option owner to generate a profit from exercising the option.
In a bullet trade scenario, the put option owner has two variables to consider. First is the price of the option. Second is the price of the underlying security. The put option owner profits from the difference in strike price and market price minus the cost of the put option.
After buying the put option, the owner has multiple options. The owner can immediately profit on the exercise of the option. They may also watch the market prices for decreases before exercising. In this scenario, to obtain the greatest profit, a put option owner would want to exercise when they believe the security has reached its lowest possible point.
To exercise the option the put owner would need to buy the security at its market price and then sell to its option counterpart at the strike price. Generally, the put owner would also be liable for any trading costs associated with the buying of the underlying security for execution which also factors into the profit.
In the Money Call Option
To execute this trade an investor buys an in the money call option. The call option gives the investor the option to buy a specified security. Call options also come with many terms including a specified exercise price, a fee and a specified timeframe to expiration.
Buying an in the money call option refers to a call option with an exercise price that is lower than the market price. This allows the call option owner to generate an immediate profit from the option. In an in the money call option bullet trade, the call option owner would need to exercise the option, obtain the security and immediately sell it in the secondary market. This scenario includes more trading costs which requires wider spreads in order to profit.