I was wondering if someone could answer a relatively simple question for me. Actually two. I have not yet traded options but I am looking at the various different combinations that one can use to make a profit. I'm not sure what this is called but it involves buying an in the money call and selling an out of the money call. First of all, am I correct in saying that is is possible under this combination for one to make a profit even if the underlying stock drops slightly before expiration. This being the case since the call sold helps defray the cost of the call purchsed and due to the fact the out of money call is mostly time premium while in the money is more intrnsic value. My other question is how margin with a broker works. I know selling naked puts you must have some margin available to buy if the stock is put to you. When only buying calls you only need enough capital to cover the purchase of the calls. In the combination I describe does one need margin to cover the sold call or is the fact you own a call of a lower strike sufficient.
bignatty... In response to the first question: You are creating a debit spread. Your maximum profit would be just below the strike of the sold call. Yes, it is still possible to profit from the position with a slight price drop depending on the prices of each leg of the spread. Margin will depend on your broker, but there are some standards in place that most brokers abide by. To give one example, here's a link to the Interactive Brokers margin webpage: http://www.interactivebrokers.com/html/retailAccount/option_margin.html You will need a margin account to sell the call, but having sold the call as part of a spread will greatly reduce the margin requirements.
Spread Maintenance Debit call spread = the debit amount (i.e. what you paid for the spread) E.g. paid $3 for 1 long call spread maintence is $300 (100% of the cost) Credit call spread = the difference between the strikes - credit received E.g. sold call spread for $3 the the maintence is $200 the most it could go against you.