You may then sell the June 117 call at 2.60, and in the same transaction pay 1.70 for the June 119 call, for a net credit of 0.90 Your position is known as the short call spread because
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Table 8.2 Long SPY June 117–119 call spread
*Short call spread
Neutral to bearish strategy
Suppose you are neutral to bearish on the S&P 500 With 45 days till expiration, June time decay is beginning to accelerate You would like to collect premium if the index stays in its current range or if it declines, but you don’t want to risk the unlimited loss from a short call You may then sell the June 117 call at 2.60, and in the same transaction pay 1.70 for the June 119 call, for a net credit of 0.90 Your position is known as the short call spread because it is similar to a short call.4
The advantage of your spread is that it has a built-in stop-loss cover at the higher strike, or 119 You may think of this spread as a potential sale of the stock at 117, and a potential buy of the stock at 119 For this risk, you collect a premium
4 This spread is also known as the bear call spread and the short vertical call spread.
1.5
10.5
0–0.5
–1
115 116 117 118 119 120 121
Figure 8.1 Expiration profit/loss relating to Table 8.2
Trang 28 Call spreads and put spreads, or one by one directional spreads 77
The expiration profit/loss of this spread is opposite to the above long call spread, but the break-even level is the same Here, the maximum profit
is the credit received from the spread, or 0.90 This profit is earned if the stock is at or below the lower strike, or 117
The maximum loss occurs if the stock is at or above the higher strike This
is calculated as the difference between strike prices minus the income from the spread, or (119 – 117) – 0.90 = 1.10
The break-even level is the same as the long call spread This is the level
at which a loss due to an increase in the stock price matches the income from the spread The calculation is the lower strike price plus the price of the spread, or 117 + 0.90 = 117.90 Below is a summary of this spread’s expiration profit/loss:
Credit from short June 117 call: 2.60
Debit from long June 119 call: –1.70
Maximum profit: credit from spread: 0.90
Maximum loss: (difference between strikes) – credit from spread:
(119 – 117) – 0.90 = 1.10
Break-even level: lower strike + credit from spread: 117 + 0.90 = 117.90The risk/return potential from this spread is also opposite to the long call spread, or maximum loss divided by maximum return at 1.10/0.90 Here, a risk of each $110 offers a potential return of $90
Table 8.3 shows the expiration profit/loss for this short call spread
Table 8.3 Short SPY June 117–119 call spread
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*Long put spread
Bearish strategy
The SPDR is currently trading at 115.22, and you are bearish, short term,
on the S&P 500 index You may wish to purchase the June 113 put to profit from a downside move With 45 days till expiration, time decay is accelerating and the implied volatility is higher than it has been recently,
so an expenditure of 3.10 or $310, may seem too great
Instead, you could sell the June 111 put at 2.60, and in the same tion pay 3.10 for the June 113 put, for a total debit of 0.50 Your short put then effectively finances the purchase of your long put, and minimises your exposure to the Greeks
transac-The trade-off is that your downside profit is limited by the 111 put, but
at that point you have probably captured the best part of the move Your analysis may tell you that the SPX is supported below 111, in which case your 111 put would effectively be the level at which you take the profit from your 113 put
In this case, you are buying the June 113–111 put spread This position
is known as the long put spread because it is similar to a long put.5 You may simply think of this spread as a potential sale of the index (the ETF)
at 113, and a potential buy of the index at 111 For this profit potential you pay a premium
In order to assess the profit/loss potential of the spread at expiration, first the price of the spread is considered as a unit: 0.50
10.5
0–0.5
–1–1.5
115 116 117 118 119 120 121
Figure 8.2 Expiration profit/loss relating to Table 8.3
5 This spread is also known as the bear put spread and the long vertical put spread.
Trang 48 Call spreads and put spreads, or one by one directional spreads 79
At expiration, the maximum profit is gained if the stock is at or below the lower strike, or 111 This is calculated as the difference between strike prices minus the cost of the spread, or (113 – 111) – 0.50 = 1.50
The maximum loss is taken if the stock is at or above the higher strike, or
113, at expiration This is calculated simply as the cost of the spread, or 0.50.The break-even level is the level at which a decline in the stock pays for the cost of the spread This is calculated as the higher strike minus the cost
of the spread, or 113 – 0.50 = 112.50 The expiration profit/loss is rised as follows:
summa-Debit from long June 113 put: –3.10
Credit from short June 111 put: 2.60
–––––
Maximum profit: difference between strikes – cost of spread:
(113 – 111) – 0.50 = 1.50
Maximum loss: cost of spread: 0.50
Break-even level: higher strike – cost of spread: 113 – 0.50 = 112.50
The risk/return potential of this spread is maximum loss divided by mum profit, or 0.50/1.50 In other words you are risking $0.33 for each potential profit of $1.00, or a risk/return ratio of 1/3.6
maxi-In tabular form the expiration profit/loss is as in Table 8.4
Table 8.4 Long SPY June 113–111 put spread
Microsoft 109 110 111 112 112.50 113 114 115 Spread
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In graphic terms, the profit/loss of this spread is illustrated in Figure 8.3
*Short put spread
Neutral to bullish strategy
On the other hand, suppose that you are neutral to bullish on the SPX
or the SPDR Your analysis tells you that it is oversold, or that earnings prospects are better than expected You would like to sell a put in order
to profit either from time decay if the index stabilises or from a decline in the put’s value if the index rallies At the same time, you do not want the exposure of a naked short put
You may then sell the June 113 put at 3.10, and in the same transaction pay 2.60 for the June 111 put, for a net credit of 0.50 This position is known as the short put spread because it is similar to a short put.7 The advantage of this spread is that if the stock declines, a possible loss is cut
at the lower strike, or 111 You may think of this spread as a potential buy
of the stock at the higher strike, or 113, and a potential sale of the stock at the lower strike, or 111 For this potential risk you collect a premium.The expiration profit/loss of this short put spread is exactly opposite to the former long put spread The maximum profit is earned if the stock is at or above the higher strike, or 113 This amount is simply the premium col-lected for the spread, or 0.50
The maximum loss occurs if the stock is at or below the lower strike, or
111 This is calculated as the difference between the strike prices minus the income from the spread: (113 – 111) – 0.50 = 1.50
1.5
2
10.5
0–0.5
–1
109 110 111 112 113 114 115
Figure 8.3 Expiration profit/loss relating to Table 8.4
7 This spread is also known as the bull put spread and the short vertical put spread.
Trang 68 Call spreads and put spreads, or one by one directional spreads 81
The break-even level is the level at which a decline in the stock matches the spread income This is calculated as the higher strike minus the price
of the spread, or 113 – 0.50 = 112.50
The profit/loss at expiration is summarised as follows:
Credit from short June 113 put: 3.10
Debit from long June 111 put: –2.60
Total credit from spread: 0.50
Maximum profit: credit from spread: 0.50
Maximum loss: difference between strikes – credit from spread:
(113 – 111) – 0.50 = 1.50
Break-even level: higher strike – credit from spread: 113 – 0.50 = 112.50The risk/return potential for this spread is also opposite to the long put spread, at maximum loss divided by maximum profit, or 1.50/0.50 Here, you risk 3.0 to make 1.00.8
In tabular form the expiration profit/loss is shown in Table 8.5
Table 8.5 Short SPY June 113–111 put spread
The graph of the profit/loss position at expiration is shown in Figure 8.4
Long versus short call and put spreads
So far we have seen that both a long call spread and a short put spread profit from an upside move Likewise both a long put spread and a short
8 I wouldn’t, but many do because supposedly ‘It’ll never happen’
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call spread profit from a downside move The question may arise as to which one is preferable The basic difference is that of buying or selling premium, and the trade-offs are similar to straight long or short positions
in calls or puts
If a long and a short spread are both out-of-the-money and equidistant from the underlying, the maximum profit of the long spread is greater than the maximum profit of the short spread, but the short spread has the greater probability to profit
The probability of either spread expiring in the money can be mated by the delta of the strike that is nearest the underlying In the above examples, both the 117 call and the 113 put have a delta that is approxi-mately 0.40 If the index has a 40 per cent probability of moving to a strike
approxi-in either direction, then the direction which is short has a 60 per cent probability of collecting its premium The maximum loss, however, is greater with the short spread The maximum profit, of course, favours the long spread, and this is a fair return for an outcome that is less probable.Premium sellers often short out-of-the-money spreads that are at a safe distance from the underlying because these spreads have limited risk Premium buyers, however, can afford to place their position closer to the underlying because the cost of the spread is less than the cost of a straight call or put
–1–1.5
–2
109 110 111 112 113 114 115
Figure 8.4 Expiration profit/loss relating to Table 8.5
Trang 88 Call spreads and put spreads, or one by one directional spreads 83
If you spread the strikes, then you get a greater profit range but you pay more You need to do technical analysis to determine which strikes to
spread Also, call spreads and put spreads can be any distance from the
underlying The trade-offs are similar to those between straight money and at-the-money calls or puts The further a spread is from the underlying, the less cost or income it has, and the less probability it has of becoming in-the-money
out-of-the-1×1s and volatility skews
In the stock or bond markets, the out-of-the-money put spread often costs less than the equidistant out-of-the-money call spread This is because the lower strike put is priced higher than the higher strike call, although they are the same distance from the underlying In the above example, the 111 put is 2.60 while the 119 call is 1.70 This is a function of what are known
as volatility skews, which are discussed in Part 3
In commodities, however, the call spreads are often cheaper than the distant put spreads because there is a positive call skew
equi-But don’t be bewildered at this point If you spread
1×1s then you minimise your exposure to the
skews Long call spreads and long put spreads are
the safest way to trade options
A final note
The difference between a spread and a straight call or put is that the spread’s maximum profit/loss can be quantified at the outset For the longs, the cost of the spread is the maximum loss, and if the trader is good with technicals, he can pick his levels For the shorts, these spreads allow for premium selling with a built-in stop-loss order On a risk/return basis they can be recommended to everyone, especially beginners
Long call spreads and long put spreads are the safest way to trade options
Trang 10One by two directional spreads
There are other ways of financing the purchase of a directional position Those that we will discuss in this chapter are variations of the long call and put spreads Again, they involve buying an option to take advantage
of a chosen market direction But instead of selling one, they sell two options at the strike price that is more distant from the underlying
The spreads in this chapter are suitable for slowly trending markets, and they are unsuitable for markets that are trending rapidly higher or lower,
or volatile markets that are subject to sudden shifts in direction
Long one by two call spread
Bullish strategy
The long one by two call spread is a long call spread with an additional
short call at the higher strike If XYZ is at 100, you could buy one 105 call and sell two 115 calls in the same transaction This spread is also known as the one by two ratio call spread or the one by two vertical call spread
In order to trade this spread, your outlook should call for the underlying
to increase to a level that is near, but not substantially above, the higher strike This spread, like the long call spread, has its maximum profit if the underlying is at the higher strike at expiration It is less costly than the long call spread because it is financed by an extra short call But because of the extra short call, this spread has the potential for unlimited loss if the underlying rallies substantially The extra short call includes added expo-sure to the Greeks
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With Coca-Cola at 52.67, examine the August options on offer1(60 days until expiration):
Strike 40 42.50 45 47.50 50 52.50 55 57.50 60
August puts 0.34 0.47 0.82 1.30 2.05 2.90
Here, you could pay 1.45 for one August 55 call and sell two August 60 calls
at 0.34 for a net debit of 0.77 At expiration, the maximum profit occurs if the stock closes at the higher strike; this is the same level as with a long call spread at the same strike This profit is calculated as the difference between the strike prices less the cost of the spread, or 60 – 55 – 0.77 = 4.23
Because of the extra short call there are two break-even levels The lower break-even level is, like the long call spread, the lower strike price plus the cost of the spread, or 55 + 0.77 = 55.77
The upper break-even level is the maximum profit plus the higher strike price, or 60 + 4.23 = 64.23
Above the upper break-even level this spread takes a loss equivalent to the amount that the stock increases A summary of the profit/loss at expira-tion is as follows
Debit from August 55 call: 1.45
Credit from two August 60 calls: 2 × 0.34 = –0.68
Maximum loss: unlimited upside
In order to evaluate the risk/return potential of this spread, you must sider the upside potential of the stock or underlying Remember that the maximum loss is potentially unlimited
con-1 Data courtesy of the Chicago Board Options Exchange, CBOE
Trang 129 One by two directional spreads 87
In tabular form, the expiration profit/loss is as shown in Table 9.1
Table 9.1 Coca-Cola long August 55-60 one by two call spread
0–2
Figure 9.1 Expiration profit/loss relating to Table 9.1