Call Spreads - Leg In?

[Chris Mankamyer 10]

It appears that many traders when purchaing a call spread do so by buying and selling the 2 strikes on the same day same trade. I understand why to sell the higher strike call for time decay, delta, and reducing the effects of time decay, but if one is bullish why not buy just the call then wait for a move higher in the option and then sell the short? It appears to be a much more profitable trade. Spread gurus I'd love to hear from you.

 

Chris Mankamyer

[MadMarketScientist 11]

Hi,

 

The reason one does a spread is to offset the cost of the bullish call ... so to ensure they can do this, its safest to get into the position at the same time - in case the trade turns against them and they are never able to sell the call for the same premium.

 

But if you are really bullish why even bother with a spread at all? You are just limiting your potential gains.

 

MMS

[MightyMouse 12]

When I do these I generally will do them as credit spreads and find opportunities below the market for bullish put spreads and above the market for bearish call spreads.

 

So if you have a $52-3 stock that has been volatile, making the option premiums richer, you might be able to sell a 45 put and buy a 40 in the expiring month for a credit of about $1.70. It is rare for the premium to be higher than that.

 

If the stock goes up you make money. If it does nothing you make money. If it goes down you can make money if it stays above $43.30, and you lose money if it goes down below 43.30.

 

It's a great way to take advantage of recent volatility on a stock. It is a bet that future volatility will be less than current volatility.

[SIUYA 11]

It appears that many traders when purchaing a call spread do so by buying and selling the 2 strikes on the same day same trade. I understand why to sell the higher strike call for time decay, delta, and reducing the effects of time decay, but if one is bullish why not buy just the call then wait for a move higher in the option and then sell the short? It appears to be a much more profitable trade. Spread gurus I'd love to hear from you.

 

Chris Mankamyer

 

You are missing the obvious alternatives that could occur to then best assess why...

1.... The simplest answer is that if you buy the call the instrument goes up - why not just sell out the call you made money on, sell out some of the calls, hedge with a partial short OR let it all ride?

2...The instrument goes down and rather than only loosing the cost of the spread you loose the full cost of the single call

 

As MM suggests another way may be to leg into various months (series).

You have assumed the best solution and then depending on where the strikes costs etc are, you need to assess the situation.

 

simplistic example; stock $10, buy the $11 strike call at $1, stock rallies to $12, $11 strike call maybe worth now $2.

if you sell it out now you make $1 (net cost now 0)

if you sell the $13 call at say $1, you might at expiry either make <=$1 if it stays here or falls.

or the max is making another $1 (but thats all)

 

so if the market falls or stays still you are no better off.

[MadMarketScientist 11]

So if you have a $52-3 stock that has been volatile, making the option premiums richer, you might be able to sell a 45 put and buy a 40 in the expiring month for a credit of about $1.70. It is rare for the premium to be higher than that.

 

Hey MM I didn't know you traded options. Would you have a recent example where you used this on a stock and it worked out?

 

thx

MMS

[Chris Mankamyer 10]

Hi,

 

The reason one does a spread is to offset the cost of the bullish call ... so to ensure they can do this, its safest to get into the position at the same time - in case the trade turns against them and they are never able to sell the call for the same premium.

 

But if you are really bullish why even bother with a spread at all? You are just limiting your potential gains.

 

MMS

 

I figured that was the main reason. Any thoughts on back ratios to not limit up side but lower the cost?

 

Chris Mankamyer