35 lines
2.1 KiB
Plaintext
35 lines
2.1 KiB
Plaintext
Chapter 8: Bear Spreads Using Call Options 187
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Example: An investor is bearish on XYZ. Using the same prices that were used for
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the examples in Chapter 7, an example of a bear spread can be constructed for:
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XYZ common, 32;
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XYZ October 30 call, 3; and
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XYZ October 35 call, 1.
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A bear spread would be established by buying the October 35 call and selling the
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October 30 call. This would be done for a 2-point credit, before commissions. In a
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bear spread situation, the strategist is hoping that the stock will drop in price and that
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both options will expire worthless. If this happens, he will not have to pay anything
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to close his spread; he will profit by the entire amount of the original credit taken in.
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In this example, then, the maximum profit potential is 2 points, since that is the
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amount of the initial credit. This profit would be realized if XYZ were anywhere
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below 30 at expiration, because both options would expire worthless in that case.
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If the spread expands in price, rather than contracts, the bear spreader will be
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losing money. This expansion would occur in a rising market. The maximum amount
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that this spread could expand to is 5 points - the difference between the striking
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prices. Hence, the most that the bear spreader would have to pay to buy back this
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spread would be 5 points, resulting in a maximum potential loss of 3 points. This loss
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would be realized if XYZ were anywhere above 35 at October expiration. Table 8-1
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and Figure 8-1 depict the actual profit and loss potential of this example at expiration
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(commissions are not included). The astute reader will note that the figures in the
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table are exactly the reverse of those shown for the bull spread example in Chapter
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7. Also, the profit graph of the bear spread looks like a bull spread profit graph that
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has been turned upside down. All bear spreads have a profit graph with the same
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shape at expiration as the graph shown in Figure 8-1.
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TABLE 8-1.
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Bear spread.
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XYZ Price at October 30 October 35 Total
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Expiration Profit Profit Profit
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25 +$300 -$100 +$200
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30 + 300 - 100 + 200
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32 + 100 - 100 0
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35 - 200 - 100 - 300
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40 - 700 + 400 - 300 |