Bull call spread

[tezz]

Hi Guys, can anyone explain how this spread works, advantages/disadvantages, do you need to own the shares, do you need a broker or can this trade be transacted on the PC, and what is the dollar outlay to get into a trade like this, I have never seen this in any option books.
XYZ currant price $10.00
buy april $9.75 calls at .20 dr
sell april $10.25 calls at .10 cr
nett cost .10
I dont dig it

 

[Nick Radge]

Bull Calls spreads are common. The main difference from buying an outright call is that the profit is limited and the net cost is cheaper because of the financing offered by the short call.

Maximum profit will occur if prices settle right at the upper level, in this case $10.25. The maximum profit is the difference between the two strikes minus the cost, so here the maximum profit is $0.40. Not a bad risk reward at 4:1 though - although this may change when adding in the bid/offer spreads. Usually you should only take an options trade if the risk/reward is >3.

One would only use this kind of strategy if they think that the upside is limited, so in this case perhaps $10.25 is a major resistance level and its your beleif that prices will not move past there.

Negatives:
(1) If prices shoot higher you have no extra profits. Solution: Exit the short $10.25 call as prices break higher.

(2) Extra brokerage from a two sided strategy as well as (an Australia) paying away the bid/offer spread on two legs. Solution: Trade US options.

Positives:
(1) Lowers the net cost of making the trade verse say buying an outright call.

(2) Can be managed by lifting/adding legs as conditions change.

Whenever making an options trade you should do one thing before all else:

Find out what volatility is doing. Is it high or low.

Volatility will determine the type of trade that should be placed. High vol. means selling strategies are best. Low vol. means that buying strategies are best. There are numerous strategies available, so always look at all aspects and all strategies to find the best for your outlook.

Personally I like selling ITM spreads or buying ratio backspreads. Suggest reading Sheldon Natenberg or doing a search through these pages for WayneL's comments.

 

[NettAssets]

I wish I could find 25c intrinsic + a month and a half of time for 20c.
John

 

[ugotdan]

Does the Net Delta of a Bull Call Spread affect the BE and outcome of your profits???
EG. on paper, the profit for XYZ may be 0.40c, but the deltas of the options may only add up to, say 0.3... so you may need to wait for the stock's price to move much higher than the short strike before exiting??
Is this correct?
If so, what sort of net delta is acceptable for these spreads?

 

[sails]

Does the Net Delta of a Bull Call Spread affect the BE and outcome of your profits???
EG. on paper, the profit for XYZ may be 0.40c, but the deltas of the options may only add up to, say 0.3... so you may need to wait for the stock's price to move much higher than the short strike before exiting??
Is this correct?
If so, what sort of net delta is acceptable for these spreads?

I don't think there is a simple answer as there are too many variables. Seminar gurus probably have some figure to look intelligent, but the reality is, it depends...

It depends on volatility and where and how the spread is positioned. A close spread will have different deltas and behave differently to a wider spread; whether the position is atm, otm or itm; whether it is positioned close to expiry or further out in time.

Suggest you have a look at option chains ranging over several months to see what will happen in the future if volatility remains the same. You can also see what happens if price moves up, down or stays the same. While not perfect, it is a simple exercise that gives some understanding on how time and price affect a position.

To guage the effect of volatility, try the hoadley Options Strategy Evaluation Tool (OSET). The basic version is free and probably all you would need to compare call spreads with differing volatilities: http://www.hoadley.net/options/optionstools.htm

Hope that helps - I'm getting a bit rusty on some of this now.....lol