Bear spread option strategy example
This is known as time erosion. Since a bear call spread consists of one short call and one long call, the sensitivity to time erosion depends on the relationship of the stock price to the strike prices of the spread. This happens because the short call is closest to the money and erodes faster than the long call. This happens because the long call is now closer to the money and erodes faster than the short call.
If the stock price is half-way between the strike prices, then time erosion has little effect on the price of a bear call spread, because both the short call and the long call erode at approximately the same rate.
Stock options in the United States can be exercised on any business day, and holders of a short stock option position have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options. While the long call higher strike in a bear call spread has no risk of early assignment, the short call lower strike does have such risk.
Early assignment of stock options is generally related to dividends, and short calls that are assigned early are generally assigned on the day before the ex-dividend date. In-the-money calls whose time value is less than the dividend have a high likelihood of being assigned. Therefore, if the stock price is above the strike price of the short call in a bear call spread the lower strike price , an assessment must be made if early assignment is likely.
If assignment is deemed likely and if a short stock position is not wanted, then appropriate action must be taken. Before assignment occurs, the risk of assignment can be eliminated in two ways. The entire spread can be closed, which involves buying the short call to close and selling the long call to close.
Alternatively, the short call can be purchased to close and the long call open can be kept open. If early assignment of a short call does occur, the obligation to deliver stock can be met either by buying stock in the marketplace or by exercising the long call.
Note, however, that whichever method is chosen, the date of stock acquisition will be one day later than the date of the stock sale. This difference will result in additional fees, including interest charges and commissions. Assignment of a short call might also trigger a margin call if there is not sufficient account equity to support the stock position created by the option assignment.
There are three possible outcomes at expiration. The stock price can be at or below the lower strike price, above the lower strike price but not above the higher strike price or above the higher strike price. If the stock price is at or below the lower strike price, then both calls in a bear call spread expire worthless and no stock position is created.
If the stock price is above the lower strike price but not above the higher strike price, then the short call is assigned and a short stock position is created. If the stock price is above the higher strike price, then the short call is assigned and the long call is exercised. The result is that stock is sold at the lower strike price and purchased at the higher strike price and the result is no stock position.
A bull call spread consists of one long call with a lower strike price and one short call with a higher strike price. A bear put spread consists of one long put with a higher strike price and one short put with a lower strike price. Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author.
Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Since the put options with higher strike price is more expensive, the investor incurs a certain cost while setting up the strategy.
However, if the asset price remains below the strike price of the options he bought, the trader makes a profit from the difference between the strike price and the stock price at maturity minus the cost of setting up the strategy.
Bear put spreads are useful if investors are slightly bearish on a stock. This strategy can be replicated using two call options as well -- in which case, it would be known as a bear call spread. A bull call spread is a strategy of buying a number of call options at a certain strike price and selling the exact number of call options with same expiration and underlying asset at a higher strike price.
Since the value of the calls with the lower strike price is higher, the trader incurs a cost in setting up the strategy. However, if the asset price rises above the strike price of the calls he bought, the trader earns a profit from the difference between the strike price and the stock price at maturity minus the cost of setting up the strategy. A safer, better and more successful strategy can be to purchase deep 'in the money" call options and sell against them "at the money" or "slightly in the money" Call options.
Beats most games of chance. Bull call spreads are useful if investors are slightly bullish on a stock, i. This strategy can be replicated using two put options as well -- in which case, it would be known as a bull put spread. A bear call spread is a strategy of buying a number of call options at a certain strike price and selling the same number of call options at a lower strike price with the same maturity and underlying asset.
Since the value of the calls with the lower strike price is higher, the trader earns a small profit if the stock price falls below the strike price at which he sold the options. On the other hand, he limits his downside. If the stock price increases dramatically, he would lose money on the options he sold but recover some of it as stock price crosses the strike price of the options he bought. Bear call spreads are useful if investors are slightly bearish on a stock.
This strategy can be replicated using two put options as well -- in which case, it would be known as a bear put spread. From the makers of. Unable to complete your request. Please refresh your browser. See more recent news. Huge bull call on United Continental.
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