why bullish or bearish spreads versus just buying calls and puts?
If a stock is going up or down rapidly, a straight put or call purchase will often outperform an 'equivalent' spread. If, however, the stock is moving more slowly in time and/or price, a spread will often (I am tempted to say 'almost always') outperform the simple long position. One example (using ATM calls and an ATM bull spread):
- Buy 10 QCOM ATM calls (Jan 165) at close today for $15,750, or
- Buy a 16 contract bull spread (long Jan 155s, short Jan 175s) at the close today for a net debit of 9.75 points (conservative!), total investment $15,600.
Investment amounts are therefore roughly equal; neither position requires additional margin. On expiration day, you'd have:
QCOM price 155 165 175 185 195 205
long call p/l% -100% -100% -36% +27% +90% +154%
spread p/l% -100% +2% +105% +105% +105% +105%
So in this example it's not until Q hits about 197 1/2 (22% above its current level) that the long call begins to outperform the spread. And note that in the case where Q basically tracks sideways for the next three weeks and expires around 165, the spread still breaks even - but the long call expires completely worthless.
There are many other advantages of spreads that I don't have time to go into here (more limited downside, increased flexibility [in being able to close either side 'early'], protection from high premiums and large bid/ask spreads, and greater leverage are four that come to mind).
In the end, spreads are another tool in the option toolchest, as completely different from simple call/put purchases as those strategies are from buying the stock itself. Each is appropriately matched with your risk tolerance and (more importantly) your expectation for the future price trend of the underlying equity. Ignoring or denigrating any one investment technique because another has worked well "so far" is to limit your potential profits and the ultimate safety of your portolio.
-Rose- |
