Friday, February 20, 2009

Bear Call Recap

I wanted to highlight a recent bear call spread I played with on the $RUT. Vertical credit spreads are often my weapon of choice when looking to exploit market moves. First off, I like milking the higher rate of time decay offered by short term options. - I typically put these on around 6 weeks out. Furthermore, the wider range of profit (e.g. high probability of profit), offered by OTM spreads appeals to my nature. So let's evaluate the numbers-


Feb 4th - $RUT @ 455
Sell to Open March 530 @ $2.60
Buy to Open March 540 @ $1.45
Net Credit = $1.15
Max Reward = $1.15
Max Risk = $8.85
Delta of March 530 = .12
Probability of Profit = 88%
Potential ROI = 115 / 885 = 13%

I typically look to buyback any credit spread I enter at around $.25 or less. The rationale behind exiting early is simple, I lock in the gain, remove risk, and free up my money to go elsewhere.

Feb 18th (14 day trade)
Exit the spread at $.25, netting a $.90 profit
Net ROI = $90 / $885 = 10%

Although I entered using 6 week options, I was able to exit after a mere 2 weeks. I’ll take a 10% return in 2 weeks all day long. Now if I could only get my entire portfolio to net 10% every couple weeks… lol.
I'll do a market recap a bit later.



Ram said...


In your example, how do you calculate the probability of profit? (88%)


Tyler said...

Great question Ram. I simply looked at the delta of the short call (530), which was 12. This implies that there is a 12% chance of the 530 call residing ITM at expiration. In a bear call spread, I realize my max profit if the lower strike call (530) is OTM at expiration. The formula is: 1 - delta of short call. So 1 - 12 = 88%.


Great recap