was going up. They were right and still lost money. As the adage goes,
timing is everything. The more time that passes, the more advantageous the
lower-theta vertical spread becomes. When held until expiration, a vertical
spread can be a better trade than an outright call in terms of percentage
profit.
In the previous example, when Apple is at $391 with 40 days until
expiration, the 395 call is worth 14.60 and the spread is worth 4.40. If
Apple were to rise to be trading at $405 at expiration, the call rises to be
worth 10, for a loss of 4.60 on the 14.60 debit paid. The spread also is worth
10. It yields a gain of about 127 percent on the initial $4.40 per share debit.
But look at this same trade if the move occurs before expiration. If Apple
rallies to $405 after only a couple weeks, the outcome is much different.
With four weeks still left until expiration, the 395 call is worth 19.85 with
the underlying at $405. That’s a 36 percent gain on the 14.60. The spread is
worth 5.70. That’s a 30 percent gain. The vertical spread must be held until
expiration to reap the full benefits, which it accomplishes through erosion
of the short option.
The long-call-only play (with a significantly larger negative theta) is
punished severely by time passing. The long call benefits more from a
quick move in the underlying. And of course, if the stock were to rise to a
price greater than $405, in a short amount of time—the best of both worlds
for the outright call—the outright long 395 call would be emphatically
superior to the spread.