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Buying the call gives you the right to buy stock at strike price A. Selling the two calls gives you the obligation to sell stock at strike price B if the options are assigned. This strategy enables you to purchase a call that is at-the-money or slightly out-of-the-money without paying full price. The goal is to obtain the call with strike A for a credit or a very small debit by selling the two calls with strike B.
Ideally, you want a slight rise in stock price to strike B. So beware of any abnormal moves in stock price and have a stop-loss plan in place. Some investors may wish to run this strategy using index options rather than options on individual stocks. You may wish to consider running this strategy shorter-term; e. Due to the unlimited risk if the stock moves significantly higher, this strategy is suited only to the most advanced option traders. If you are not an All-Star trader, consider running a skip strike butterfly with calls.
You want the stock to rise to strike B and then stop. If established for a net debit, there are two break-even points: Strike A plus net debit paid to establish the position. Strike B plus the maximum profit potential. If established for a net credit, there is only one break-even point:. If established for a net debit, potential profit is limited to the difference between strike A and strike B, minus the net debit paid.
If established for a net credit, potential profit is limited to the difference between strike A and strike B, plus the net credit. Margin requirement is the requirement for the uncovered short call portion of the front spread. If established for a net credit, the proceeds may be applied to the initial margin requirement.
After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase or decrease in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-unit basis.
For this strategy, time decay is your friend. However, that will be outweighed by the decrease in value of the two options you sold good.
After the strategy is established, in general you want implied volatility to go down. The closer the stock price is to strike B, the more you want implied volatility to decrease for two reasons. First, it will decrease the value of the near-the-money options you sold at strike B more than the in-the-money option you bought at strike A.
Second, it suggests a decreased probability of a wide price swing, whereas you want the stock price to remain stable at or around strike B and finish there at expiration. 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.
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Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results.
All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between. The Strategy Buying the call gives you the right to buy stock at strike price A. Options Guy's Tips Some investors may wish to run this strategy using index options rather than options on individual stocks.
All options have the same expiration month. Break-even at Expiration If established for a net debit, there are two break-even points: If established for a net credit, there is only one break-even point: The Sweet Spot You want the stock price exactly at strike B at expiration.
Maximum Potential Profit If established for a net debit, potential profit is limited to the difference between strike A and strike B, minus the net debit paid. Maximum Potential Loss If established for a net debit: Risk is limited to the debit paid for the spread if the stock price goes down. Risk is unlimited if the stock price goes way, way up.
If established for a net credit: Ally Invest Margin Requirement Margin requirement is the requirement for the uncovered short call portion of the front spread. As Time Goes By For this strategy, time decay is your friend. Implied Volatility After the strategy is established, in general you want implied volatility to go down.
This graph assumes the strategy was established for a net credit.