Description
If the strike
price of the two
options is the same,
a Long Call/Short
Put position is
equivalent to a
Long Stock position.
However, this strategy
is often designed
using options with
two different strikes.
For example, with
XYZ at $60, the
investor would build
the spread using
the 65 Call and
the 60 Put (A.K.A.
- Collar).
When to use
Because this
position is either
equivalent to long
stock (same strike
price) or closely
approximates long
stock (split strikes),
the investor utilizing
this strategy must
be aware of its
risk/reward profile.
(Unlimited risk
and unlimited reward!)
This strategy is
most often used
when XYZ is near
the mid-point between
the two split strike
prices. First, the
spread is often
established for
little or no debit.
And secondly, it
provides a little
room for XYZ to
decline before the
Put becomes in-the-money.
Risk/Reward
Characteristics
Like Long Stock,
the spread's potential
is unlimited. Losses
are unlimited because
the investor could
end up with a long
stock position if
assigned on the
short Put. Because
of this fact, the
investor must carefully
consider the initial
size of the spread!
Break-even
Point: If debit
spread: Call strike
price + spread debit;
If credit spread:
Put strike price
- spread credit
Time Decay:
Varies. If XYZ is
near Long Call strike
price, time decay
is a negative for
the spread. If XYX
is near Short Put,
time decay is a
positive.
Volatility:
Neutral. If volatility
increases, both
options increase
in price. Thus,
the gain in the
Call offsets the
loss in the Put.
If volatility decreases,
the gain in the
Put offsets the
loss in the Call.
Assignment
Risk: The investor
must watch XYZ for
possible assignment
if XYZ declines
below the Put's
strike.
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