39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
Chapter 8: Bear Spreads Using Call Options
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SELECTING A BEAR SPREAD
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189
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Depending on where the underlying stock is trading with respect to the two striking
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prices, the bear spread may be very aggressive, with a high profit potential, or it may
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be less aggressive, with a low profit potential. If a large credit is initially taken in,
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there is obviously the potential for a good deal of profit. However, for the spread to
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take in a large credit, the underlying stock must be well above the lower striking
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price. This means that a relatively substantial downward move would be necessary in
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order for the maximum profit potential to be realized. Thus, a large credit bear
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spread is usually an aggressive position; the spreader needs a substantial move by the
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underlying stock in order to make his maximum profit. The probabilities of this
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occurring cannot be considered large.
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A less aggressive type of bear spread is one in which the underlying stock is
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actually below the lower striking price when the spread is established. The credit
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received from establishing a bear spread in such a situation would be small, but the
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spreader would realize his maximum profit even if the underlying stock remained
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unchanged or actually rose slightly in price by expiration.
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Example: XYZ is trading at a price of 25. The October 30 call might be sold for 1 ½
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points and the October 35 call bought for½ point with the stock at 29. While the net
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credit, and hence the maximum profit potential, is a small dollar amount, 1 point, it
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will be realized even if XYZ rises slightly by expiration, as long as it does not rise
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above 30.
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It is not always clear which type of spread is better, the large credit bear spread
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or the small credit bear spread. One has a small probability of making a large profit
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and the other has a much larger probability of making a much smaller profit. In gen
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eral, bear spreads established when the underlying stock is closer to the lower strik
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ing price will be the best ones. To see this, note that if a bear spread is initiated when
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the stock is at the higher striking price, the spreader is selling a call that has mostly
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intrinsic value and little time value premium (since it is in-the-money), and is buying
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a call that is nearly all time value. This is just the opposite of what the option strate
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gist should be attempting to do. The basic philosophy of option strategy is to sell time
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value and buy intrinsic value. For this reason, the large credit bear spread is not an
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optimum strategy. It will be interesting to observe later that bear spreads with puts
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are more attractive when the underlying stock is at the higher striking price!
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A bear spread will not collapse right away, even if the underlying stock drops in
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price. This is somewhat similar to the effect that was observed with the call bull
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spreads in Chapter 7. They, too, do not accelerate to their maximum profit potential
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right away. Of course, as time winds down and expiration approaches, then the spread |