41 lines
2.4 KiB
Plaintext
41 lines
2.4 KiB
Plaintext
Chapter 23: Spreads Combining Calls and Puts 343
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Example: A trader buys an XYZ call bull spread for 5 points. The spread uses the
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January 70 calls and the January 80 calls. Later, XYZ advances to a price of 88, but
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there is still a good deal of time remaining in the options. Perhaps the spread has
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widened out only to 7 points at that time. The trader finds it somewhat disappoint
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ing that the spread has not widened out to its maximum profit potential of 10 points.
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However, this is a fairly common occurrence with bull and bear spreads, and is one
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of the factors that may make them less attractive than outright call or put purchases.
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In any case, suppose the following prices exist:
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January 80 put, 5
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January 70 put, 2
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We can use these put prices to verify that the call spread is "in line." Notice that the
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put spread is 3 points and the call spread is 7 points (both are the January 70-January
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80 spread). Thus, they add up to 10 points the width of the strikes. When that
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occurs, we can conclude that the spreads are "in line" and are trading at theoretical
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ly correct prices.
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Knowing this information doesn't help one make any more profits, but it does
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provide some verification of the prices. Many times, one feels frustrated when he
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sees that a call bull spread has not widened out as he expected it to. Using the put
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spread as verification can help keep the strategist "on track" so that he makes ration
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al, not emotional, decisions.
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Now let's look at a similar example, in which perhaps the puts can be used to
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lock in profits on a call bull spread.
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Example: Using the same bull spread as in the previous example, suppose that one
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owns an XYZ call bull spread, having bought the January 70 call and sold the January
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80 call for a debit of 5 points. Now assume it is approaching expiration, and the stock
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is once again at 88. At this time, the spread is theoretically nearing its maximum price
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of 10. However, since both calls are fairly deeply in-the-money, the market-makers
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are making very wide spreads in the calls. Perhaps these are the markets, with the
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stock at 88 and only a week or two remaining until expiration:
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Coll
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January 70 call
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January 80 call
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Bid Price
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17.50
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8.80
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Asked Price
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18.50
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8.20
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If one were to remove this spread at market prices, he would sell his long
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January 70 call for 17.50 and would buy his short January 80 call back for 8.20, a cred- |