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8.4
Spread Positions
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|
he third type of strategy is called a spread position.
A spread
is a portfolio of calls (a
call spread) or a portfolio of puts (a put spread).
In a call spread, you buy and
sell different call options. If they differ only by the strike price, this would be a vertical
call spread. The term vertical
comes from the way option prices are sometimes reported.
The different strike prices are listed vertically, and the maturities are
listed horizontally, as in Table
8.1.
Table 8.1
Option Price Reporting and Vertical/Horizontal Spreads
|
|
Expiration Date 1 |
Expiration Date 2 |
|
|
Strike 1 (K1) |
Option Price |
Option Price |
|
|
Strike 2 (K2) |
Option Price |
Option Price |
|
Following
this terminology, a horizontal
(or calendar) spread would
fix the strike price (K) but vary the expiration date.
A diagonal
spread would vary
both strike price and expiration date.
Spreads
come in two other varieties: bullish
and bearish. As the
names imply, if you (mainly) make
money when
the price
of the underlying security rises, you have a bullish position; and
if you mainly make money when the price falls, you have a bearish
position. These positions are
shown in Figures 8.6-8.9.
Figure 8.6
Bullish Call Spread
Figure 8.7
Bearish Call Spread
Figure 8.8
Bullish Put Spread
Figure 8.9
Bearish Put Spread
Other
types of spread positions are ratio
spreads, where the ratio is the number of calls (puts) bought at a
higher strike per call (put) sold at a lower strike.
The writer of such a portfolio has a ratio
back spread. Figures 8.10
and 8.11 show the payoffs from a -1:2 call ratio spread and a 2:-1 put
ratio spread. Observe that in these positions a floor is imposed upon
possible losses, whereas the position participates in any upside gain.
In the -1:2 call ratio spread depicted in Figure 8.10, no upper
bound is imposed on the upside potential.
Figure 8.10
-1:2 Call Ratio Spread
The
2:-1 put spread in Figure 8.11 imposes an upper bound on the upside gain.
Figure 8.11
2:-1 Put Ratio Spread
Spreads
can also be used to make profits when prices are expected to remain in a
stable range. A famous
example of this is the butterfly
spread, which consists of buying a low and high strike-price call and
selling two medium strike-price calls.
The payoff from this position is depicted in Figure 8.12.
Figure 8.12
Call Butterfly Spread
The
position in Figure 8.12 can also be engineered by selling the medium puts
and buying the extreme strike-price puts, as shown in Figure 8.13.
Figure 8.13
Put Butterfly Spread
Calendar,
or horizontal, spreads are difficult to illustrate, as
the expiration dates of the options are
different. However,
you can view the payoffs from such strategies in Option Tutor. An option pricing model such as the Black-Scholes lets you value the long-dated option at the expiration
date of the short-dated option, and examine the resulting payoffs as a
function of the underlying stock price.
In
the next topic, we discuss Combination
Position Strategies.