A short call spread obligates you to sell the stock at strike price A if the option is assigned but gives you the right to buy stock at strike price B. A short call spread is an alternative to the short call.
One advantage of this strategy is that you want both options to expire worthless. You may wish to consider ensuring that strike A is around one standard deviation out-of-the-money at initiation. That will increase your probability of success. However, the further out-of-the-money the strike price is, the lower the net credit received will be from this strategy. As a general rule of thumb, you may wish to consider running this strategy approximately days from expiration to take advantage of accelerating time decay as expiration approaches.
Of course, this depends on the underlying stock and market conditions such as implied volatility. You may also be expecting neutral activity if strike A is out-of-the-money.
You want the stock price to be at or below strike A at expiration, so both options expire worthless. The net credit received when establishing the short call spread may be applied to the initial margin requirement. Keep in mind this requirement is on a per-unit basis. For this strategy, the net effect of time decay is somewhat positive.
It will erode the value of the option you sold good but it will also erode the value of the option you bought bad. After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices. If your forecast was correct and the stock price is approaching or below strike A, you want implied volatility to decrease. If your forecast was incorrect and the stock price is approaching or above strike B, you want implied volatility to increase for two reasons.
First, it will increase the value of the near-the-money option you bought faster than the in-the-money option you sold, thereby decreasing the overall value of the spread. Second, it reflects an increased probability of a price swing which will hopefully be to the downside.
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. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.
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The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between. The Strategy A short call spread obligates you to sell the stock at strike price A if the option is assigned but gives you the right to buy stock at strike price B.
Options Guy's Tips One advantage of this strategy is that you want both options to expire worthless. Both options have the same expiration month.
Break-even at Expiration Strike A plus the net credit received when opening the position. The Sweet Spot You want the stock price to be at or below strike A at expiration, so both options expire worthless. Maximum Potential Profit Potential profit is limited to the net credit received when opening the position.
Maximum Potential Loss Risk is limited to the difference between strike A and strike B, minus the net credit received. Ally Invest Margin Requirement Margin requirement is the difference between the strike prices. As Time Goes By For this strategy, the net effect of time decay is somewhat positive.
Implied Volatility After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices. Use the Technical Analysis Tool to look for bearish indicators. Use the Probability Calculator to verify that strike A is about one standard deviation out-of-the-money.More...