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Max Profit of Vertical Spread
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Max Profit of Vertical Spread

  #1 (permalink)
Trading for Fun
Baltimore MD
 
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Max Profit of Vertical Spread

So I have a question about the max profit of a vertical spread. If I understand it correctly the maximum profit of a long call or put vertical spread is calculated by subtracting the higher strike from the lower strike and then subtracting the debit you paid.

So if you own an XYZ Bull Call Spread with a Short strike of 55 and a Long strike of 50, and the premium was $2 then your maximum profit is 50-55-2 = $3.

Is this correct?

So now my real world question. I own a March DJX Bull Call Spread with a Short Strike of 159 and a Long strike of 158. The Debit was $0.58. So my max profit is 159-158-0.58 = 0.42 or $42 per contract. Over the past 2 days the DJX has moved up about 100 points. Despite this my P/L has stayed exactly the same. It seems like the long and short call are moving exactly 1 for 1. Is that normal during a period within the spread? Can I expect the P/L to move up as the theta starts to accelerate as we approach expiration, or am I missing something?

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  #2 (permalink)
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  #3 (permalink)
Hyde Park,
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Bermudan Option's Avatar
 
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With generally all spreads, until the extrinsic value of the option decays, you will not really see profit.

You are in somewhat of a catch-22 position... because your expiration date is a few months out, you have to wait for a sizeable amount of time to pass before you see some money. On the flipside though, since your position is ITM by a decent amount, once time passes and extrinsic value decreases you will have increasing odds of a potential exercise of your short calls.

To summarize even if the DJX retraces soon, you will only see profit when your risk of being assigned stock increases towards the end of the option's life. Depending on your account size, this may or may not be ideal for you. Personally I'd recommend buying Options As A Strategic Investment, and reading the chapter on Bull spreads w/ calls.

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  #4 (permalink)
Elite Member
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Hi Pete
That spread in question is now worth 80 cents so if you have bought it for 58 cents you should be in profit (based on closing prices).
See chart attached.

Attached Thumbnails
Max Profit of Vertical Spread-screen-shot-2014-01-01-8.32.21-pm.png  
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  #5 (permalink)
Trading for Fun
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Bermudan Option View Post
With generally all spreads, until the extrinsic value of the option decays, you will not really see profit.

You are in somewhat of a catch-22 position... because your expiration date is a few months out, you have to wait for a sizeable amount of time to pass before you see some money. On the flipside though, since your position is ITM by a decent amount, once time passes and extrinsic value decreases you will have increasing odds of a potential exercise of your short calls.

To summarize even if the DJX retraces soon, you will only see profit when your risk of being assigned stock increases towards the end of the option's life. Depending on your account size, this may or may not be ideal for you. Personally I'd recommend buying Options As A Strategic Investment, and reading the chapter on Bull spreads w/ calls.

Thanks. I'll look into the book.

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  #6 (permalink)
Trading for Fun
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Tradelog View Post
Hi Pete
That spread in question is now worth 80 cents so if you have bought it for 58 cents you should be in profit (based on closing prices).
See chart attached.

Yeah. I am in profit, I just expected it to continue to grow.

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  #7 (permalink)
Elite Member
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You are correct about maximum profit at expiration. BTW, you are using TOS, so you can examine any vertical on the analyze tab to view the potential profit.

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  #8 (permalink)
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Pete Schweaty View Post
Yeah. I am in profit, I just expected it to continue to grow.

Your spread is only 1 strike wide, and as such your aggregate delta is just over 2. With a delta this low, you should not expect much profit, even though the underlying is knocking it out of the park. This is one of the downsides of vertical spreads--only as it nears expiration does it really pay off.

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  #9 (permalink)
Trading for Fun
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gfmatt View Post
You are correct about maximum profit at expiration. BTW, you are using TOS, so you can examine any vertical on the analyze tab to view the potential profit.

Thanks. Ill take a look.

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  #10 (permalink)
Trading for Fun
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josh View Post
Your spread is only 1 strike wide, and as such your aggregate delta is just over 2. With a delta this low, you should not expect much profit, even though the underlying is knocking it out of the park. This is one of the downsides of vertical spreads--only as it nears expiration does it really pay off.

Thanks. I have just started trading spreads. Live and learn.

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