Call option spread strategy
You may wish to consider buying a shorter-term long call spread, e. Potential profit is limited to the difference between strike A and strike B minus the net debit paid. For this strategy, the net effect of time decay is somewhat neutral.
After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices. If your forecast was correct and the stock price is approaching or above strike B, you want implied volatility to decrease. If your forecast was incorrect and the stock price is approaching or below strike A, you want implied volatility to increase for two reasons. First, it will increase the value of the option you bought faster than the out-of-the-money option you sold, thereby increasing the overall value of the spread.
Second, it reflects an increased probability of a price swing which will hopefully be to the upside. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.
Multiple leg options strategies involve additional risks , and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract.
There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. Diagonal spreads are constructed using options of the same underlying security but different strike prices and expiration dates.
They are called diagonal spreads because they are a combination of vertical and horizontal spreads. Any spread that is constructed using calls can be referred to as a call spread, while a put spread is constructed using put options. If a spread is designed to profit from a rise in the price of the underlying security, it is a bull spread.
A bear spread is a spread where favorable outcome is obtained when the price of the underlying security goes down.
If the premiums of the options sold is higher than the premiums of the options purchased, then a net credit is received when entering the spread. If the opposite is true, then a debit is taken. Spreads that are entered on a debit are known as debit spreads while those entered on a credit are known as credit spreads. There are also spreads in which unequal number of options are simultaneously purchased and written. When more options are written than purchased, it is a ratio spread.
When more options are purchased than written, it is a backspread. Many options strategies are built around spreads and combinations of spreads.
For example, a bull put spread is basically a bull spread that is also a credit spread while the iron butterfly can be broken down into a combination of a bull put spread and a bear call spread. A box spread consists of a bull call spread and a bear put spread.
The calls and puts have the same expiration date. The resulting portfolio is delta neutral. For example, a January box consists of:.
A box spread position has a constant payoff at exercise equal to the difference in strike values. Thus, the box example above is worth 10 at exercise. For this reason, a box is sometimes considered a "pure interest rate play" because buying one basically constitutes lending some money to the counterparty until exercise.