C Jan 11 option spread question

Discussion in 'Options' started by cmhackett, Jan 15, 2010.

  1. Good morning,

    I'm relatively new to trading spreads, I've done a good bit with covered calls and some of your more basic options strategies though. I encountered a scenario that appears to be favorable for a spread and wanted confirmation that I wasn't screwing up my calculations. :)

    While looking at the Jan 11 option chain for "C" (Citigroup) I notice that I can sell a 5.0 put for a premium of $1.77, and purchase a 4.0 put for $0.99. If I were to trade a bull put spread for 40 contracts with those prices in mind:

    - If by Jan 11 "C" is trading above $5, my maximum profit (excluding comissions) is:
    (40 * $1.77) - (40 * $0.99) = $7080 - $3960 = $3120.

    - If by Jann 11 "C" is trading at or below $4, my maximum loss (excluding comissions) is:
    ($4000 {$1 diff between strikes * 40 contracts}) - ($3120 {net credit from above}) = $880.

    If I've done my math correctly (and am understanding spreads right), I have a maximum potential reward of over $3000, with a maximum potential loss of less than $1000. Am I missing something? Thank you for taking the time to review this, I've been really trying to learn options over the past two years, but it's time for my reading and study to make way for actual practice. :)
  2. MTE


    You are not missing anything. Your calculations are correct. All that is left is for the stock to go up.

    By the way, you can also buy the 4 call and sell the 5 call and have the exact same profile. The benefit is that the calls are OTM and they are more liquid.
  3. Hmmm, where did most post go? I and 2 or 3 others all replied and I know I didn't delete mine.
  4. The Goonier, I accidentally posted twice, sorry - the replies are in my thread titled "Trading credit spread - example question".
  5. Math is not the problem. The problem is the prices you used are not correct. The 4 call is about 3 to 5 cent option and the 5 call is about a 1 to 3 cent option. That means even if you could sell the 5 put on the offer and buy the 4 put on the bid the most you're going to make is somewhere in the 2 to 6 cent range since there is no real time premium in those options. ( the 4 / 5 put spread can only be worth 1 dollar or less) and you're selling it for a few pennies under parity which is where its priced.

    The prices you quoted are out of line with the real markets.

    The stock closed at 3.42 and the 4 call is worth about 3 cents at that stock price on Friday. Also with the stock at that price the 5 call is worth 1 cent maybe 2. That means based on the stock price the 4 put is (4 - 3.42 or 58 cents plus the 3 cents value of time premium in the call or a total of 61 cents) and the 5 put is (5-3.42 or 1.58 plus the time premium in the 5 call of 1 cent for a total of 1.59) SO 1.59 less .61 is 98 cents so you're selling a spread which has a max value of 1.00 for .98 cents and the only way you can make money is if the stock goes above 4.02 less commissions which is rouchly a 17.5 % move to break even.

    As someone already pointed out you could buy the 4/5 calls spread for a 3 to 5 cents and its the exact same trade.

    The only way you're making money is on a huge % move in the stock.
  6. Actually, xflat, the put prices he is quoting are correct, at least they are if Yahoo Finance is.

    I see the 4 Put at 0.98-0.99 and the 5 Put at 1.76-1.79. He will obtain a credit of at least 0.77 for his trouble, assuming he is getting the worst price being currently quoted. He risks 0.23 to make a potential 1.00.

    Of course the probability of C rising to 5.00 is theoretically well under 50%, but I'm sure he realizes that, and it certainly is priced into the equation. If the chances were 90%, he would certainly receive much less of a credit.

    As far as I can see, the numbers look correct, although I would calculate them on a spread basis to make it a bit easier to figure out and display.

    Max profit= 1.00*40*100= $4,000.00
    Max Loss= 0.23*40*100= $ 920.00

    (My numbers are slightly different than his because I'm assuming a worst price scenario.)

    Of course, there are also commissions to factor into this but they should be a relatively minor amount.
  7. He's talking about the Jan 2011 PUTS.
  8. spindr0


    Did you look at Jan '10 quotes instead of Jan '11 ??
  9. sorry I was looking at front month, my bad
  10. spindr0


    FWIW, it's a lot easier to evaluate and compare strategies by looking at only one of them. Calculating 40 spreads just makes a bit more work.

    As MTE suggested, you can also buy the 4 call and sell the 5 call and have the exact same profile (the benefit is that the calls are OTM and they are more liquid). In addition, in 6-7 months, if C is at a similar price and implied volatility, the short $5 puts will be approaching parity and you may run into early assignment issues.

    And as someone else suggested on the other chain you started, if you're trying to hit a home run (hoping a $3.50 stock goes to $5), for the same money (risk) you could buy the Jan '11 $5 call. At higher prices than $5, you'll have a much larger gain.

    Another advantage with the call is that if the stock moves up before expiration (but still below $5), it will have a much larger gain than the spread due to a higher net delta.
    #10     Jan 16, 2010