What’s my profit in this scenario

Discussion in 'Options' started by learningoptiontrading, Jun 30, 2018.

  1. I read this in an option-trading book and feel like there’s a mistake in the book and want to confirm:

    If the price of ABC stock shares is currently at $100, an investor buys a put option with a strike price of $105 that costs $8 premium per share (for a 100-share contract), and at the same time sells a put option with a strike price of $125 for $27 premium per share, or $2700 for a 100-share contract.

    If this stock closes at $110 per share, what’s my net profit per share?
  2. SmallFry



    I am still learning too. I attached a screenshot of a similar scenario on the ticker DIS (similar price and strikes) on TOS. I adjusted the contract prices to match your scenario.

    I am not too sure on how to calculate price of the spread before expiration (depends on volatility and possibly other greeks that are always changing), so I use this tool.

    If you are asking profit after expiration and exercise here is my thought on it:
    (Excluding commission and exercise fee)
    As you see from picture, the profit after expiration is $400 when the underlying is trading at $110. This is how I think you can calculate it:

    If the stock is trading at $110 at expiration,
    the long 105P would expire OTM and worthless and you lose $800.
    The short 125P would expire ITM and you would get exercised to sell 100 shares at $125.

    $125 - $110 = $15/share difference.

    -100 shares * $15/share = -$1500
    But remember you took in $2700 in premium.

    -$1500 + $2700 = +$1200

    Also you lost $800 from the long 105P.

    $1200 - $800 = $400 profit.

    Net profit per share? Not sure what that means, but if it is what I think it is,
    then $400 profit / 100 shares = $4.00 profit/share.

    To calculate your max loss or risk excluding commission, it would be difference in strike price minus the net credit of premium received.

    Strike difference = 125 - 105 = 20.00
    Premium credited = 27.00 - 8.00 = 19.00

    20.00 - 19.00 = 1.00 max loss (*100= $100)

    To calculate break even point of $106 on the underlying:

    Short strike - net credit = $125 - $19.00 = $106.00

    Anyone is welcome to correct me if I am wrong anywhere.

    Hope this helps!
    Last edited: Jun 30, 2018

    • ABC at $100
    • Buy 105 Put $8.00
    • Sell 125 Put $27.00
    • Credit $19.00 = $1900
    • ABC at $110
    • 105 Put worthless
    • 125 Put $15.00
    • $19.00 - $15.00 = $4.00 = $400 profit
    Not taking into account commissions, bid/ask spread and assuming it's option expiry day.
  3. smallfil


    You sold an option for $2700 cash, bought a put option as protection on the lower strike which expired worthless costing you $800. That gives you a net on the proceeds of $1900. However, you are required to buy 100 share of ABC at $125 even though, the current price is only $110. You lost $1500 on buying the stock at $125 but, you have net proceeds from selling the option at $1900 which means you end up pocketing $400 in profits!
  4. smallfil


    Sorry, OptionsOptionsOptions already put up the result much more clearly.
    tommcginnis likes this.
  5. DD2018


    This is a vertical bull put spread, but selling a ITM strike means you are taking on some early exercise risk.
  6. sle


    Which is fully priced in, of course, while non-optimal early exercise is good for the seller.
  7. DD2018


    Theoretically yes, but logistically it could be a hassle if you don't have the buying power, depending on the brokerage. OP is new so just letting them know it's something that could potentially happen.
    learningoptiontrading and sle like this.
  8. harryp


    You never came back with what the mistake was. Care to explain?
  9. Thank you for everyone’s help and advice! Really appreciate it and happy to see so many replies to my first post in this forum. Can already see the value of this community! :) The book claimed that the net profit in this scenario is $1900, but I calculated many times and got $400 so wanted to make sure I didn’t misunderstand the whole concept. The explanation offered by the book is $2700-$800=$1900, which apparently is only part of the story. For anyone who is curious, I was reading Jeff Tomasulo’s book Tactical Income. I was at an option trading workshop hosted by Interactive Trader last weekend where they insisted that Jeff Tomasulo’s book is correct and that the correct answer is $1900. Glad to hear from you all that I’m not the only one who got $400 as the correct answer.
    #10     Jul 6, 2018
    harryp likes this.