Investing in the share market is risky, even for individuals who have ample experience in the stock market. While some investors may choose to spread to a stock outright, others may want to use a call spread to minimize their losses.
The call spreads (also known as option spread) strategy is developed when an equal number of call options are bought and sold simultaneously. Unlike the call buying strategy, which offers unlimited profits, a call spread provides limited profits, but they are also cheaper to implement.
Types of Call Spreads
This approach is called vertical spread when call options are bought and sold simultaneously on the same security and the same expiration dates but different striking prices. However, it can be classified into two classes based on the relative values of the strike prices:
- Bull Option Spread: Here, the trader buys call options on security at a specific strike price. Also, the trader sells the same number of options at a higher strike price of the same expiration date.
- Bear Option Spread: Here, the trader buys call options on security at a specific strike price. But the trader sells the same number of options at a lower strike price of the same expiration date.
An option spread calculator calculates both the bull and bear call spread, thus providing maximum to minimal profits/losses.
Features of Best Calculator
An option spread calculator should contain all the variables included in calculating the bull and bear option spread.
Effect of Stock Price Change
An option spread may get affected by the rise or fall of the stock prices. This means that a bull option spread has a “net positive delta,” whereas a bear option spread has a “net negative delta.” This delta estimates how much an option price may change as the stock prices go up and down.
Effect of Change in Volatility
Volatility is a crucial key in option prices which measure how much a stock price fluctuates in percentage terms. As volatility rises, and if the stock price and expiration time remain constant, the options prices rise too.
There is very little change in a bull option spread when the volatility changes, similarly for bear option spread, which changes little when volatility occurs.
Impact of time
The option’s total price in the time value portion decreases as expiration approaches, and this process is known as time erosion.
In a bull spread, the sensitivity to time erosion is dependent on the stock price in relation to the strike price of the spread.
However, if the stock price is “closer to” or above the strike price, then with each passing time, bull option spreads increase. If the stock price is in the middle of the strike prices, the time erosion will have little effect on option spread.
Position at Expiration
In an option spread, there are three possible outcomes at expiration for stock prices:
- At the lower strike price
- below the lower strike price
- above the lower strike price
A good option spread calculator should take all the variables to arrive at a precise value. The above factors’ values should be placed at the calculator to arrive at a decision as to if the trader should take a risk with its investment.