In the Money Spread Trade

[Thomas Leeman]

I need some objective feedback on this strategy.

I want to execute an ITM spread on AAPL

SELL APR PUT - $200
SELL APR CALL - $150

Apple (AAPL) is currently at $175. This trade receives a combined premium of $79 per share. A nice credit to the account. There is an excess of $29 over the spread range of $50.

So here are my scenarios.


First, for the PUT option if the share price exceeds $200 you keep the premium. If it is less than $200 then you would either pay to close out your position by the amount of the difference or you would buy the shares at $200.

Second, for the CALL, if the price is less $150 then you simply keep the premium. If it exceeds $150 then then you could close out the position or sell an existing postion for $150.

Therefore if the stock price remains between $150 and $200 two things happen. You Buy the stock for $200 and Sell it for $150. That's a $50 loss which is offest by the $79 you received previously for a net gain of $29 per share or $2,900 per contract.

From a risk management perspective that also mean that between $121 and $229 per share you cannot lose money. A spread of $108 range from now to April.

If the price were move outside of that range you can trade the option contracts to move the range to avoid a loss.

 

[filiaga]

So, if your trading American options you have to consider early assignment of those short positions. What would they be?

If assigned the Long put early, you buy the stock at 200, what would you do with the short call? Your stock cost basis would be 200 - 79 = 121, so you could wait until you're assigned the Short Call, but what if you're not assigned the short call, because share value moves below 150? You could close both posiitons the long stock and the short call and book your profits which would be the cost to buy back the short call added to the 121, cost basis of your underlying stock, subtracted from the value at which you sell the long stock for. So as long as your sale price for the stock is greater than 121 and the premium needed to buyback the short call, you're looking good.

As you've pointed out as long as share value remains between 121 and 229 through April expirations, you're in a good position. You seem to have an idea of what to do if the trend moves share value outside of your range, but again, consider what you need to do if anything, if early assignment occurs.

You can consider closing the trade early based on decreasing options values to book some of that $29 of extrinsic value.

 

[urv_sriram]

Since there is a probability of early assignment in the American Options, a look back period of 2 to 3 years is considered minimum to assess how many times the particular stock has gone up or down to that extent.

Personally, I trade the Index (European Options) to avoid the problem of early assignment.