I am having trouble
understanding spreads as
you describe on pages 81 - 83, Rolling For Opportunity. You talk
write about "selling a time spread," and "Buy back the all and sell a
new call in a spread transaction." I thought a spreads involved taking
positions on two options at the same time. Could you please
elaborate. I am involved in this with my United Airline stock I own on
the May 35's. (As a retiree we all got a distribution from the
bankruptcy settlement and I use it for covered calls now.)
Hello Stefan,
OK.
A spread is a transaction that involves (at least) two
different options.
A spread usually involves buying one option and selling
another, but it may involve buying (or selling) both a put and a call.
The spread under discussion in the book involves buying one call option
and selling another call option.
If you have no position and enter an order for a spread,
when the order is filled, you be taking (as you would expect) a
position on 2 options at the same time (each is called a 'leg'). For
example, spread order: Buy the IBM Oct 95/100 call spread. That means
buy the Oct 95 call and sell the Oct 100 call.
If you already have a position, you may enter a spread order
that involves 'closing' an existing position and opening another.
Example: Let's say you currently own 500 shares of UAUA and you
previously sold 5 UALEG (May 35 calls).
A time spread, or calendar spread, involves two options of
the same underlying stock. The strike prices are identical. Only the
expiration month varies.
If you buy the option with the longer expiration, you are
said to be 'buying the time spread.' If you sell the option with the
longer time to expiration, you are 'selling the time spread.'
If you roll the position (sometimes it will be for
opportunity, sometimes it will be because you don't like any
alternatives) by entering a spread order to 'buy 5 UAL May 35 calls and
sell 5 UAL Jun 35 calls' you are selling the time spread.
Note: this is a true spread transaction, as it involves
two different options. But, when the trade is executed, your new
position is: long 500 shares and short 5 Jun 35 calls. You executed a
spread, but your new position involves only one option. That's because
part of your spread involved 'buying May 35 calls to close' and
the other part involved 'selling the Jun 35 calls to open.'
With this trade, the May 35 calls disappear from your portfolio and the
Jun 35 calls take their place.
Note: In the event that you are assigned an exercise
notice before you have a chance to repurchase those May 35 calls (this
is a possible, but unlikely scenario), it's too late to roll the
position. In fact you would have no position remaining. You could
start a new position by buying stock and writing (selling) Jun 35
calls, but you would no longer be able to roll the original position.
One usually waits until very near expiration before
rolling. But, if the price available for the 'UAL Jun/May 35 call
spread' is attractive to you, then you can certainly sell that spread
to roll the position early. To me, that means 'rolling for
opportunity'