Option Spreads Intro
Presented at
ABQ Market Traders Meetup
June 26, 2013
By Ted Heath
Introduction to Option Spreads
• There are many different kinds of Option
Spreads
• Traders like Option Spread because there
is less risk involved. In fact, for most
Option Spreads you know up front your
max loss and max gain.
• They all involve Buying and Selling more
than one option (usually in the same
brokerage transaction)
Vertical Option Spreads
• The most commonly used Option Spreads
are Vertical Option Spreads
• They are called Vertical because they
involve Buying and Selling a Call or
Buying and Selling a Put for the same
stock and the same expiration date.
Types of Vertical Option
Spreads
•
•
•
•
Bull Call Spread (Debit Spread)
Bull Put Spread (Credit Spread)
Bear Call Spread (Credit Spread)
Bear Put Spread (Debit Spread)
Debit = You Buy It
Credit = You Sell It
MORE Definitions?
• Terms you need to know:
– Strike Price
– Intrinsic Value
– Extrinsic Value
– In The Money (ITM)
– At The Money (ATM)
– Out of The Money (OTM)
IBM Options Expiring
08/17/2013
Strike Price
The price of the stock at which option is
written. It may above, below, or at the
current price of the stock.
Intrinsic Value
• The amount the Option is “In The Money”
and is the difference between the Strike
Price and the Current Market Price of the
underlying asset.
• For a Call
– Strike Price LESS than the Stock Price
• Intrinsic Value = Stock Price – Strike Price
• For a Put
– Strike Price Greater than the Stock Price
• Intrinsic Value = Strike Price – Stock Price
Extrinsic Value
• Extrinsic Value (EV) is calculated by the
Black Scholes formula and is a decaying
asset. EV is the difference between an
option’s price and its Intrinsic Value and
will be worth $0.00 at expiration.
In The Money (ITM)
• An ITM Option has Intrinsic Value
• ITM Calls
– Options which have a Strike Price LESS
THAN the Current Stock Price
• ITM Puts
– Options which have a Strike Price GREATER
THAN the Current Stock Price
At The Money (ATM)
• An ATM Option has no Intrinsic Value
• ATM Calls
– Options which have a Strike Price EQUAL TO
the Current Stock Price
• ATM Puts
– Options which have a Strike Price EQUAL TO
the Current Stock Price
Out of The Money
• An OTM Option has no Intrinsic Value
• OTM Calls
– Options which have a Strike Price GREATER
THAN the Current Stock Price
• OTM Puts
– Options which have a Strike Price LESS
THAN the Current Stock Price
IBM Options Expiring
08/17/2013
Remember
•
•
•
•
•
Types of Vertical Option Spreads
Bull Call Spread (Debit Spread)
Bull Put Spread (Credit Spread)
Bear Call Spread (Credit Spread)
Bear Put Spread (Debit Spread)
Debit = You Buy It
Credit = You Sell It
Bull Call Spread
• Generally used when we anticipate
profiting from a mild rise in a particular
stock while maintaining a lower-risk profile
than owning the stock or a straight call
option
• Involves buying lower strike calls while at
the same time selling an equal number of
higher strike calls of the same stock with
the same expiration
UNH Chart
Bull Call UNH
Buy Sep 55 Call Sell Sep 70 Call
UNH SEP 55/70 Bull Call
Risk Graph
Profit/Loss Bull Call UNH
Bull Put Spread
• Generally used when we anticipate
profiting from a mild rise in a particular
stock while maintaining a lower-risk profile
than owning the stock or a straight call
option
• Involves buying lower strike Put Options
while at the same time selling an equal
number of higher strike Puts of the same
stock with the same expiration
Bull Put UNH
Buy Sep 57.5 Put Sell Sep 60 Put
UNH SEP 57.5/60 Bull Put
Risk Graph
Profit/Loss Bull Put UNH
Bear Put
Spread
• Generally used when there is anticipation
from a mild decline in a particular stock
while maintaining a lower risk profile as
opposed to shorting a stock or buying a
straight put option.
• Involves buying higher strike Put Options
while at the same time selling an equal
number of lower strike Puts of the same
stock with the same expiration
IBM Chart
Bear Put IBM
Buy Aug 210 Put Sell Aug 195 Put
IBM Aug 210/195 Bear Put
Risk Graph
Profit Loss Bear Put IBM
Bear Call Spread
• Generally used when there is anticipation
from a mild decline in a particular stock
while maintaining a lower risk profile as
opposed to shorting a stock or buying a
straight put option.
• Involves buying higher strike Call Options
while at the same time selling an equal
number of lower strike Calls of the same
stock with the same expiration
Bear Call IBM
Buy Aug 220 Call Sell Aug 215 Call
IBM SEP 57.5/60 Bear Call
Risk Graph
Profit Loss Bear Call IBM
Horizontal Call
Calendar Spread
• The Horizontal Call Calendar Spread is
generally used when there is anticipation
of profiting from stagnation or bullish rise
in a particular stock. In the simplest terms,
it involves simultaneously buying long term
call options while selling an equal number
of short term call options with the same
strike price.
Horizontal Call Calendar
Guidelines
• Buy to open ATM or OTM call options with
3-6 months or more until expiration.
• Sell to open an equal number of short term
(2-6 weeks out expiration) call options at
the same Strike Price as the ones you are
buying,
• Make sure the premium you receive is
worth selling (> or = 10% of cost of ones
bought). (This is a debit spread)
Horizontal Call Calendar
Process
• Sell Close in 2-6 Weeks out expiration Options
• Buy 3-6 Month out expiration Options
• If Close in Option is In The Money (ITM), roll to
next month
• If Close in Option is Out of The Money (OTM) let it
expire and sell next month Option at same Strike
Price
• Repeat until reach expiration month of Option
bought
• If market turns or gain is good enough close out
Example GOOG 875
Horizontal Calls
•
•
•
•
Sell
Jun @15.04 Cr
Jul @ 31.60 Cr
Sep @ 54.20 Cr
Buy
Net
Sep @ 42.23 Dr 27.19 Dr
Jun @ 16.10 Dr 15.50 Cr
Jul @ 30.20 Dr 24.00 Cr
• Net Gain = $2341
Grand Net
27.19 Dr
11.69 Dr
23.41 Cr