Hey guys. I trade the NQ and don't deal in options at all and my knowledge is limited on them. A friend of mine posed a scenario to me that I can't debunk. It seems too simple and easy and in my experience, when that's the case you are missing something. So please let me know whats missing in the following scenario. I changed the stock and price amounts, but its a mirror image of the one he proposed to me. He is getting signed up now so he will be probably be the one who comes back. Anyways A deeply in the money call option for the month of november is $10.00 (this is the middle ground between the current bid/ask) Another option at the same strike, but for the december is $10.50 (middle ground between the current bid/ask) Couldn't you buy 1 contract of the december option, for $10.50, then sell one contract of the november for $10.00, costing you a total of only $.50 per contract? Assuming you lose 50% due to time value, when the option you sold gets exercised it won''t cost you anything because hold an option at the same strike so you are able to deliver the shares to him. You are then left with all kinds of money. What's wrong with this scenario?
You end up loosing the .50 when you excercise to deliver. Calendar spreads are profitable when the short near term option decays faster than the long longer term option.
XYZ = 100.00 Sell NOV 90 call = 10.00cr Buy DEC 90 call = 10.50db Net .50db NOV call is excercised you are credited 9000.00 and deliver 100 shares of XYZ You excercise the the DEC call to offset the credit and short position. The .50 premium is lost.
Jonbig - why do you think you're left with "all kinds of money?" I don't see all this free money you're talking about. Are you forgetting that in order to deliver the stock without taking a short position, you have to exercise your long calls? And that once you've exercised them, they're gone?
Everything. 1) There is no "all sorts of money." You will own December options and be short stock. After Nov expiration, you have the same position as if you owned the Dec 50 put. And buying that put may be a profitable trade, it not likely and your most likely outcome is the loss of the premium you paid for the spread. 2) You will probably have to pay more than 50 cents to buy this spread. 3) You only have 'all sorts of money' when the stock drops well below the strike price before your long options expire in December. Mark http://blog.mdwoptions.com/options_for_rookies/
Maybe your friend is taken with the idea of getting the dec call for .50 net debit instead of 10.50. Trading options is all about trade offs. The trade off here for the cheap dec call is the risk of the short nov call. Meaning all your possible profit from correcting guessing direction could be taken if the move happens in Nov. The only way I see all kinds of money (putting aside the question of different types and probability of exercise) is if the underlying price stays below nov strike until nov x and then proceeds straight up past the strike. In that scenario, the net is that you have purchased a long ITM call for very cheap.
You would probably do better doing a Bull put credit spread, or a Bear call credit spread, providing you have the account size to meet the margin requirements. Ex. GOOG = $360 If you think the stock will go further down or stay neutral, use the Bull put, opposite if you think the stock will go up. ( do this with about 10 days before expiration to reduce some risk) BC Spread: Sell the 420 (3.20) Buy the 430 (1.83) Credit 1.37 per contract. BP Spread: Sell the 270 (3.40) Buy the 260 (2.5) Credit of .90 per contract. Rough example, but it get you the idea. I never do Debit spreads, only credit spreads.