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Discussion in 'Options' started by ZEAK, Sep 21, 2009.

1. ### ZEAK

Did my first option Bear Call spread on Royal Bank of Canada stock last week, and want to see if I understand it fully.

RY (Royal Bank) is the underlying stock. I am bearish on it, and so used this spread to limit my risk. I sold a call option with a strike price \$54 and received a premium of \$3.05 per share. I sold one contact and that is equal to 100 shares, so I received \$305 for selling this call.

I then bought a call option at a higher strike price of \$60 for a cost of \$0.91, or \$91. So my max profit is \$305- \$91= \$215. I will receive the full amount if in 6 weeks, on the third Friday of Oct, RY is trading below \$54.

Is this correct so far?

My break even point is the lower strike (\$54) plus the premium received (\$2.15) so break even is \$56.15.

Instead of calculating Return on Investment, I changed it to Return on RIsk, as my total risk is the difference between the two strike prices (\$60 - \$54)= \$6 minus the premium received (\$2.15) as I keep this regardless. So total risk is \$3.85, or \$385.

Max risk is \$385
Max return is \$215

Return on Risk = \$215/\$385 = 55.84%

That sounds great, but is the reality that my Risk to reward ratio is very poor? I am risking more than my possible return. If this is so, why do people do spreads?

I only did one contract, as its my first spread. Will see how it works out in 6 weeks!!

Thanks for any input.

2. ### heiasafari

ForexForex is wrong, you are correct on your max risk and reward. Now what you would need to do (if its not already done) is to estimate your likelyhood that RY will expire below 54\$. That is the only way you can estimate if your risk/reward ratio is worth it. You cannot say in itself if the ratio you have is good or bad, its all about probabilities...

3. ### dagnyt

1) It is very wrong to believe that you must - or even that you should - wait 6 weeks. You may wait until the options expire, but that is not necessarily a good idea.

2) You may close this spread any time you are satisfied with the profit. Yes, you may be leaving some money on the table, but when you exit, you also remove all risk.

3) The risk/reward is not terrible. Why do you think it is?

4) Probability of success is very important. If you have a 90% chance of winning (for example), wouldn't a r/r of 55% be VERY attractive?

If your chances of winning were only 10%, then you know that 55% would be a bad wager on your part.

Mark
http://blog.mdwoptions.com

4. ### wartrace

The option is only 100 shares, not 1000. Five dollar spread = 500.00

5. ### wartrace

Are you SURE about the numbers? I just looked at RY and there is no October 54 strike. The Oct 55 strike is only .85 cents & the 60 call is 0

6. ### heiasafari

I suspect he did it on the Canadian side, the oct 54 "closed" at 3.30...

Ahhhh , an option spreadâ¦I was expecting Teen Hottie II journalâ¦

8. ### ZEAK

Good point. I will monitor the trade and the underlying and possibly look to book profit if any.

Just from learning about trading futures, alway have profit targets larger than stop loss, but these are different instruments, so will keep that in mind.

Yes, it would. So I guess I need to be more certain in my_believe of what the underlying will do.