Stock Options: What am I missing between these two bull spreads?
Company XYZ is currently trading at merely below 50.00.
Scenario #1:
Buy 50.00 Jan09 beckon at 10.00
Sell 70.00 Jan09 ring at 3.00
Net cost = (10.00 - 3.00) = 7.00
Max profit = (20.00 - 7.00) = 13.00
% gain = 86%
Scenario #2:
Buy 50.00 Jan09 telephone call at 10.00
Sell 55.00 Jan09 bid at 9.00
Net cost = (10.00 - 9.00) = 1.00
Max profit = (5.00 - 1.00) = 4.00
% gain = 300%
Why would someone recommend #1 over #2? Is in that something I am not seeing?
#1 costs more, have a much lower possible gain, and it would bear a much larger hop within the underlying price in a row to realize the maximum gain.
Why would I fairly risk 7.00 for a stock to step up 20.00 within 18 months for an 86% gain, when I could risk merely 1.00 for a stock to dance up solely 5.00 contained by 18 months for a 300% gain?
What am I missing?
Answers:
Your prices don't clear sense. If the 50 strike telephone call is 10 and the 55 strike give the name is 9, later the 60 strike send for must be at lowest 8. (To see this, form the butterfly spread by buying the 50 strike beckon [for 10], selling two 55 strike call [for 18] and buying the 60 strike nickname. If the spread costs smaller quantity than or equal to nil, nearby is an arbitrage, so the 60 strike call upon must be strictly greater than 8 if vol is greater than nothing.)
Keep applying this logic. A nine price for the 55 call upon and a greater than eight price for the 60 phone up mode that the 65 strike phone call must be greater than 7. Now we with the sole purpose know that the 60 strike ring up is at least possible 8 and the 65 strike send for is greater than 7. (We cannot extend our logic to the 70 bid.)
However, that routine that the 65-70 ring up spread is greater than 7-3 = 4. But the price of the 55-60 strike telephone spread is 4. So I'd buy the 55-60 strike give the name spread and market the 65-70 name 'til the cows come home. Arbitrage shown. Your prices cannot co-exist contained by the bazaar, though they might co-exist within the tabloid.
My fancy is that your price for the 55 strike name is only too lofty (at 9).
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Scenario #1:
Buy 50.00 Jan09 beckon at 10.00
Sell 70.00 Jan09 ring at 3.00
Net cost = (10.00 - 3.00) = 7.00
Max profit = (20.00 - 7.00) = 13.00
% gain = 86%
Scenario #2:
Buy 50.00 Jan09 telephone call at 10.00
Sell 55.00 Jan09 bid at 9.00
Net cost = (10.00 - 9.00) = 1.00
Max profit = (5.00 - 1.00) = 4.00
% gain = 300%
Why would someone recommend #1 over #2? Is in that something I am not seeing?
#1 costs more, have a much lower possible gain, and it would bear a much larger hop within the underlying price in a row to realize the maximum gain.
Why would I fairly risk 7.00 for a stock to step up 20.00 within 18 months for an 86% gain, when I could risk merely 1.00 for a stock to dance up solely 5.00 contained by 18 months for a 300% gain?
What am I missing?
Answers:
Your prices don't clear sense. If the 50 strike telephone call is 10 and the 55 strike give the name is 9, later the 60 strike send for must be at lowest 8. (To see this, form the butterfly spread by buying the 50 strike beckon [for 10], selling two 55 strike call [for 18] and buying the 60 strike nickname. If the spread costs smaller quantity than or equal to nil, nearby is an arbitrage, so the 60 strike call upon must be strictly greater than 8 if vol is greater than nothing.)
Keep applying this logic. A nine price for the 55 call upon and a greater than eight price for the 60 phone up mode that the 65 strike phone call must be greater than 7. Now we with the sole purpose know that the 60 strike ring up is at least possible 8 and the 65 strike send for is greater than 7. (We cannot extend our logic to the 70 bid.)
However, that routine that the 65-70 ring up spread is greater than 7-3 = 4. But the price of the 55-60 strike telephone spread is 4. So I'd buy the 55-60 strike give the name spread and market the 65-70 name 'til the cows come home. Arbitrage shown. Your prices cannot co-exist contained by the bazaar, though they might co-exist within the tabloid.
My fancy is that your price for the 55 strike name is only too lofty (at 9).