39 lines
2.6 KiB
Plaintext
39 lines
2.6 KiB
Plaintext
204
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XYZ common, 70;
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XYZ July 50, 20;
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XYZ July 60, 12; and
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XYZ July 70, 5.
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Part II: Call Option Strategies
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The butterfly spread would require a debit of only $100 plus commissions to estab
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lish, because the cost of the calls at the higher and lower strike is 25 points, and a 24-
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point credit would be obtained by selling two calls at the middle strike. This is indeed
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a low-cost butterfly spread, but the stock will have to move down in price for much
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of a profit to be realized. The maximum profit of $900 less commissions would be
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realized at 60 at expiration. The strategist would have to be bearish on XYZ to want
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to establish such a spread.
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Without the aid of an example, the reader should be able to determine that if
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XYZ were originally at 50, a low-cost butterfly spread could be established by buying
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the 50, selling two 60's, and buying a 70. In this case, however, the investor would
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have to be bullish on the stock, because he would want it to move up to 60 by expi
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ration in order for the maximum profit to be realized.
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In general, then, if the butterfly spread is to be established at an extremely low
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debit, the spreader will have to make a decision as to whether he wants to be bullish
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or bearish on the underlying stock. Many strategists prefer to remain as neutral as
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possible on the underlying stock at all times in any strategy. This philosophy would
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lead to slightly higher debits, such as the $300 debit in the example at the beginning
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of this chapter, but would theoretically have a better chance of making money
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because there would be a profit if the stock remained relatively unchanged, the most
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probable occurrence.
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In either philosophy, there are other considerations for the butterfly spread.
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The best butterfly spreads are generally found on the more expensive and/or more
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volatile stocks that have striking prices spaced 10 or 20 points apart. In these situa
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tions, the maximum profit is large enough to overcome the weight of the commission
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costs involved in the butterfly spread. When one establishes butterfly spreads on
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lower-priced stocks whose striking prices are only 5 points apart, he is normally put
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ting himself at a disadvantage unless the debit is extremely small. One exception to
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this rule is that attractive situations are often found on higher-priced stocks with
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striking prices 5 points apart (50, 55, and 60, for example). They do exist from time
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to time.
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In analyzing butterfly spreads, one commonly works with closing prices. It was
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mentioned earlier that using closing prices for analysis can prove somewhat mislead
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ing, since the actual execution will have to be done at bid and asked prices, and these |