Value of a Call Spread
Jul 23, 2010

Bullish Trades. III
Call Spreads

Last time we looked at buying a call spread when the strike prices were 5 points apart..

This is a typical example of a debit spread.  That means that the calls bought have a higher premium (price) than the calls sold.
Buy 5 RGTO Dec 35 calls
Sell 5 RGTO Dec 40 calls

When you own this position, there are several things that the new options trader must understand
  • This position is a call spread (buy one call and sell another; with same expiration date)
  • This position is bullish.  Buy this when you expect the stock to move higher
  • Maximum profit occurs when the stock is above the higher strike ($40 in this example) price at expiry
  • Maximum value for this spread is $5 (worth $500)
    • The $5 value is $5 per share, and each option represents 100 shares of RGTO stock.  Thus, $500 value
    • Why can this position be worth $5 and no more?
      • Anytime the stock is above $40 - and it does not matter how far above
      • You own the Dec 35 call and have the right to buy stock by paying $35
      • You sold the Dec 40 call and are obligated to sell stock at $40 (only when stock is above $40)
      • Thus, you pay $35 and sell at $40.  Net cash to you is $500, less commission
      • The maximum profit is $500 less the price paid for the spread
  • Minimum value for the spread is zero
    • When expiration arrives and stock is below $35 (the lower strike price), both options expire worthless
    • Maximum loss is price paid for the spread
The call spread is an example of a hedged position with limited loss and limited gains.

Mark D Wolfinger

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