I entered a BUY Vertical trade -- BUY +1 Vertical AMZN 100 20 Sep 19 1807.5/1820 CALL @ 6.50 LMT (To open/to close) The max profit is $600, max loss is $650, cost of trade including commission is $652. From my understanding, cost of trade is how much i have to pay to enter this trade. Max profit is how much I will earn if this trade turns out to be successful. Max loss is when this trade is a total write-off. Please correct me if my understanding is wrong and also can someone explain to me why my max profit is less then my cost of trade? I am using TOS platform TQ
just google it ... In options trading, a vertical spread is an options strategy involving buying and selling of multiple options of the same underlying security, same expiration date, but at different strike prices. They can be created with either all calls or all puts.
If AMZN closes 1820 or higher on Sept 20, then your short call will either expire worthless (if it closed right at 1820) or ITM and will get exercised if AMZN closes higher than 1820. Your long call will be auto-exercised whenever it is ITM. So the position will be worth as much as the delta between the two strikes (1820 - 1807.5 = $1250). But that won't be your profit because you already paid a $650 debit to put the trade on. Your max profit will be $1250 - $650 = $600 (minus commissions). Since it is a defined-risk trade, you are only risking the premium paid to put the trade on or $650. Currently, at the time of this writing, AMZN is $1823. So your position is already fully in the money. The options market is assigning a slightly greater than 50% probability that your position will expire ITM. That is based on the delta of your overall position which should be around 0.5. As you get closer to expiration, your delta will become more sensitive to price changes in the underlying. If you instead bought an OTM vertical call spread, then the max profit should be greater than the cost of the trade because the market should be assigning a less than 50% chance of the position being ITM. To get people to take that kind of risk, the risk : reward must be skewed. Tastytrade.com explains this stuff pretty well.
My only added comment is, at the start, this is a ~1:1 (risk:reward) trade with a delta of ~50, meaning it is just like a coin flip? What is @moolah's thesis that this type of trades will be profitable in the long run, in aggregate?
Ignoring commissions: A long vertical must be paid for. That is the risk. The potential profit is the difference in strikes less the premium paid. If the cost of the spread exceeds half the spread's width then the potential loss exceeds the potential gain.