43 lines
2.5 KiB
Plaintext
43 lines
2.5 KiB
Plaintext
Chapter 23: Spreads Combining Calls and Puts 331
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vantages are connected with some of the methods of establishing the butterfly
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spread.
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Example: The following prices exist:
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Strike:
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Call:
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Put:
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XYZ common: 60
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50
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12
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60
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6
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5
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70
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2
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1 1
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The method using only the calls indicates that one would buy the 50 call, sell two 60
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calls, and buy the 70 call. Thus, there would be a bull spread in the calls between the
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50 and 60 strikes, and a bear spread in the calls between the 60 and 70 strikes. In a
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similar manner, one could establish a butterfly spread by combining either type of bull
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spread between the 50 and 60 strikes with any type of bear spread between the 60 and
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70 strikes. Some of these spreads would be credit spreads, while others would be debit
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spreads. In fact, one's personal choice between two rather equivalent makeups of the
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butterfly spread might be decided by whether there were a credit or a debit involved.
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Table 23-1 summarizes the four ways in which the butterfly spread might be
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constructed. In order to verify the debits and credits listed, the reader should recall
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that a bull spread consists of buying a lower strike and selling a higher strike, whether
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puts or calls are used. Similarly, bear spreads with either puts or calls consist of buy
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ing a higher strike and selling a lower strike. Note that the third choice - bull spread
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with puts and bear spread with calls - is a short straddle protected by buying the out
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of-the-money put and call.
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In each of the four spreads, the maximum potential profit at expiration is 8
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points if the underlying stock is exactly at 60 at that time. The maximum possible loss
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in any of the four spreads is 2 points, if the stock is at or above 70 at expiration or is
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at or below 50 at expiration. For example, either the top line in the table, where the
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spread is set up only with calls; or the bottom line, where the spread is set up only
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with puts, has a risk equal to the debit involved - 2 points. The large-debit spread
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(second line of table) will be able to be liquidated for a minimum of 10 points at expi
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ration no matter where the stock is, so the risk is also 2 points. (It cost 12 points to
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begin with.) Finally, the credit combination (third line) has a maximum buy-back of
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10 points, so it also has risk of 2 points. In addition, since the striking prices are 10
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points apart, the maximum potential profit is 8 points (maximum profit = striking
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price differential minus maximum risk) in all the cases. |