Global Economic Intersection
Advertisement
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
Global Economic Intersection
No Result
View All Result

When Is A Bullish Spread Not A Bullish Trade?

admin by admin
June 21, 2013
in Uncategorized
0
0
SHARES
1
VIEWS
Share on FacebookShare on Twitter

Online Trading Academy Article of the Week

by Russ Allen, Online Trading Academy Instructor

Many bullish option positions are purely directional. When we buy Call options, we win if the price of the underlying goes up; otherwise, we lose.

There are many types of elaborations on the simple purchase of Calls. I described some of them last week, including the Vertical, Horizontal, and Diagonal spreads; the Butterfly; and the Call Ratio Backspread. As described there, each of these spreads just added one or more short call options to a basic long call position. The spreads were designed to maintain the bullish bias of the position, while bringing in some money from the short options to offset the cost of the long options. Each of these spreads has its place, depending on your degree of bullishness, and your outlook on implied volatility.

But besides their use as bullish trades, some of these same spreads can be used in a fundamentally different way.

First, let’s look at Vertical spreads. In this case we’re talking about the Bull Call spread, where we buy calls at one strike, and sell the same number of calls at a higher strike (same expiration). Instead of constructing Bull Call spreads so that the underlying’s price must go up in order to profit, we can put them together so that all the underlying has to do is not go down too much. Thus instead of a directional, bullish position, the same type of spread can provide a nearly price-neutral position. Its profit then comes not from movement in price, but from time decay. This transformation comes by selecting strike prices where both the long and short options are already in the money.

With this strategy (in-the-money debit spread), although we don’t need it, we won’t mind upward price movement, no matter how high. We won’t mind downward price movement either, as long as it’s not too large. A very large downward movement is the only thing that can keep us from making our maximum profit.

Let’s look at Gannett Corp. (GCI). I selected this stock because its IV is quite high at this time (June 12). When we use Bull Call Spreads as a neutral strategy, we will be short time value, and relying on time decay for our profit. So high volatility going in is a good thing; we are being paid a relatively large amount for the time value we’re selling.

For any strategy where we are net short time value, we want to take advantage of the rapid acceleration in time decay during the last 60 days or less of an option’s life. GCI has July options that expire in 37 days, within our 60-day window, so we’ll select that expiration.

Below is GCI’s price chart. It’s been in a range between $20.00 and 22.00 for a couple of months now. It has support levels below at roughly $19.50, $19.00 and $18.50. It’s reasonable to expect that it will hold above $18.00 for the next few weeks.

Figure 1: GCI Price Chart
Click to enlarge

Looking at the option chain, we find that the $18 July calls can be sold for $2.30, while the July 16 calls can be bought for $4.00 (all option prices shown are at the midpoint between the Bid and Ask prices). The net cost is ($4.00 – $2.30) = $1.70. This debit to our account is the maximum that this position can lose. This maximum loss would happen only if GCI were below $16.00 at expiration, which is extremely unlikely. In that event, both options would be out of the money and therefore worthless, and so would our position.

Our maximum profit would be realized if both options are still in the money until expiration. At expiration, all in-the-money options are worth exactly their intrinsic value, which is equal to the amount by which they are in the money. At any price above our $18 short call strike, both the $16 and the $18 calls will have intrinsic value. Since $18 is always exactly $2 more than $16, when both options have non-zero intrinsic value, their values must be exactly $2 apart. In that case, the spread will be worth exactly $2.00. Since we paid $1.70 for the spread, our profit will be ($2.00 – $1.70) = $.30.

Our breakeven price would be that price of GCI where we could recover the $1.70 cost by selling our long $16 call for that much; that is, the price where the $16 call is $1.70 in the money. That price is ($16.00 + $1.70) = $17.70. The payoff diagram for the spread is shown below:

Figure 2: GCI July 2013 16/18 Bull Call Spread Payoff Diagram
Click to enlarge

It may seem that the risk/reward ratio on this trade is not good risking $1.70 to make $.30? But there are two additional factors we need to take into account.

First, we would not plan to hold this position if price dropped below the short strike at $18.00. At that price, if it occurred today, before any time decay has had a chance to happen, our loss would be about $.70 per share, not $1.70. With each day that passes, our short $18 call loses more time value than our long $16 call; Our P/L at a GCI price of $18 improves every day, eventually rising to our $.30 profit.

Secondly, we need to take into account the probabilities of the important price levels. Based only on the current price and the stock’s volatility, an estimate of the probability of any price at any time in the future can be calculated. In the diagram below, I’ve calculated probabilities for 37 days out, which is the July expiration.

Figure 3: Probability of Profit
Click to enlarge

In the diagram above, the probability of being above $18.00 is shown as 76.72%. That means that we have a 76.72% chance of making our maximum $.30 profit. The probability of finishing below our $17.70 breakeven price is shown as 19.72%. So we have a 19.72% chance of losing money. Our chance of making some profit, not necessarily our maximum profit, is 81.29% (the 76.72% chance of finishing above $18.00, plus the 3.57% chance of finishing between $17.70 and $18.00). Not shown in this diagram is a 5.64% chance of GCI being below $16, in which case we’d make our $1.70 maximum loss.

So we have a 77% chance of making our maximum profit; an 80% chance of making some profit, and a 20% chance of losing money. That 20% includes a 6% chance of making our maximum loss.

These probabilities are calculated by a formula that cannot read charts. It therefore doesn’t know that there are multiple support levels above $18. We believe that the probabilities are even better than the formula calculates.

With these odds, the trade makes sense.

Experienced traders know that this Bull Call Spread is equivalent to a Bull Put Spread using the same strike prices. In this case, the $18.00 put could have been sold for $.45, and the $16.00 put purchased for $.15. The maximum profit is ($.45 – $.15) = $.30. In this case (and it won’t always be true) that thirty-cent profit is exactly the same as for the Bull Call Spread. The maximum loss is the same as well at $1.70, and therefore the margin requirement is that amount, the same as the Bull Call Spread. Both spreads profit from the greater time decay of the $18 call compared to the $16 call and are in all respects identical in their payoff and risk.

So a Bull Call Spread, which is usually used as a bullish directional trade, can also be used as a neutral income-generating device that is based on time decay. This can be useful when a trader’s option approval level allows debit spreads (approval level 3) but not credit spreads (approval level 4). There are also occasions when differences in the specific option prices make a debit spread and the “equivalent” credit spread have different payoffs, rather than being identical as in this example. In that case the debit spread may be the better choice.

It’s not just Vertical spreads that can be “repurposed“ to do something different from their most common uses. In future weeks we’ll discuss others.

Previous Post

India: Rupee Record Low Against U.S. Dollar

Next Post

Investing.com Technical Analysis 20 June 2013

Related Posts

Will Ethereum Outperform Bitcoin?
Economics

Will Ethereum Outperform Bitcoin?

by John Wanguba
May 30, 2023
Is ReFi The Future Of DeFi?
Finance

Is ReFi The Future Of DeFi?

by John Wanguba
May 30, 2023
What Is Regenerative Finance (ReFi)?
Finance

What Is Regenerative Finance (ReFi)?

by John Wanguba
May 30, 2023
How Will The US Debt Ceiling Crisis Affect Bitcoin Price
Economics

How Will The US Debt Ceiling Crisis Affect Bitcoin Price

by John Wanguba
May 29, 2023
Blockchain-Based Reusable KYC Is A ‘Breakthrough’ For Web3 Security
Business

Blockchain-Based Reusable KYC Is A ‘Breakthrough’ For Web3 Security

by John Wanguba
May 29, 2023
Next Post

Investing.com Technical Analysis 20 June 2013

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Browse by Category

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Browse by Tags

adoption altcoins bank banking banks Binance Bitcoin Bitcoin adoption Bitcoin market blockchain BTC business China crypto crypto adoption cryptocurrency crypto exchange crypto market crypto regulation decentralized finance DeFi Elon Musk ETH Ethereum Europe Federal Reserve finance FTX inflation investment market analysis Metaverse NFT nonfungible tokens oil market price analysis recession regulation Russia stock market technology Tesla the UK the US Twitter

Archives

  • May 2023
  • April 2023
  • March 2023
  • February 2023
  • January 2023
  • December 2022
  • November 2022
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • June 2022
  • May 2022
  • April 2022
  • March 2022
  • February 2022
  • January 2022
  • December 2021
  • November 2021
  • October 2021
  • September 2021
  • August 2021
  • July 2021
  • June 2021
  • May 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • August 2010
  • August 2009

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized
Global Economic Intersection

After nearly 11 years of 24/7/365 operation, Global Economic Intersection co-founders Steven Hansen and John Lounsbury are retiring. The new owner, a global media company in London, is in the process of completing the set-up of Global Economic Intersection files in their system and publishing platform. The official website ownership transfer took place on 24 August.

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Recent Posts

  • Will Ethereum Outperform Bitcoin?
  • Is ReFi The Future Of DeFi?
  • What Is Regenerative Finance (ReFi)?

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

No Result
View All Result
  • Home
  • Contact Us
  • Bitcoin Robot
    • Bitcoin Profit
    • Bitcoin Code
    • Quantum AI
    • eKrona Cryptocurrency
    • Bitcoin Up
    • Bitcoin Prime
    • Yuan Pay Group
    • Immediate Profit
    • BitIQ
    • Bitcoin Loophole
    • Crypto Boom
    • Bitcoin Era
    • Bitcoin Treasure
    • Bitcoin Lucro
    • Bitcoin System
    • Oil Profit
    • The News Spy
    • British Bitcoin Profit
    • Bitcoin Trader
  • Bitcoin Reddit

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

en English
ar Arabicbg Bulgarianda Danishnl Dutchen Englishfi Finnishfr Frenchde Germanel Greekit Italianja Japaneselv Latvianno Norwegianpl Polishpt Portuguesero Romanianes Spanishsv Swedish