1988issue C121-3
Credit verticals for modest index moves
A mild-direction view is written into the strike width, moneyness and days to expiry of a vertical credit spread. Both legs are then sent as one spread order that names the accepted net difference, so entry, the payoff band and abstention stay a single procedure.
- A vertical credit spread sells options and buys the same quantity of same-expiry options farther out of the money, so the sold contracts are priced higher and the account receives a net credit.
- Strike width, moneyness and a short hold to expiry encode the expected modest range; for cash-settled index options the result is fixed by the index close at expiry.
- A call-credit-spread is the structure paired with a modest expected decline, and a put-credit-spread is the counterpart paired with a modest expected rise.
- Opening or closing either spread is specified as one spread order that names both legs and the net difference, optionally with all-or-nothing or fill-or-kill terms.
What a vertical credit spread is
A vertical credit spread is opened by selling options and buying the same quantity of same-expiry options farther out of the money. The sold contracts are priced higher, so the account receives a net credit.
The brokerage requirement equals the strike difference times 100, so a five-point credit spread requires 500 before the opening credit reduces net capital in use.
The illustrated call-credit-spread
On 6 July 1988, with the OEX at 262.07, the illustrated call-credit-spread sold 10 July 255 calls at 8-1/2 and bought 10 July 260 calls at 4-3/4 for a net outlay of 1449 including commissions.
Those strikes were chosen because a small downward move would sit inside the profitable band, and the July 260 calls were treated as 10 percent cheap relative to their quoted price.
The call-credit-spread was intended to be held about 10 days to expiry. The result was fixed solely by the OEX close on 15 July because in-the-money cash-settled index options settled automatically in cash.
Expiry band and a long-put comparison
At expiry the call-spread diagram reached about 3600 if the OEX finished at 255 or lower, and about -1800 if it finished at 260 or higher. The result moved linearly between those strikes and was roughly flat near 258.
Relative to buying five July 260 puts at a price of 3, the call-credit-spread was more profitable between 250 and 260, while the long puts were better if the index fell below 250.
The put-credit-spread counterpart
A counterpart put-credit-spread sold 10 July 270 puts at 9-1/2 and bought 10 July 265 puts at 5-7/8 for 1583. It showed about the same 3600 and -1800 extremes and was the structure paired with a modest expected rise.
Both legs as one spread order
Opening or closing either spread was specified as one spread order that names both legs and the net difference. All-or-nothing or fill-or-kill terms could be added so the two sides are obtained together.
All readings on this track · 5 readings
- 1988Credit verticals for modest index moves
- 1990Inflexible option spreads, psychology, and neglected stops
- 2020Two-week paired stops with an options-flow filter
- 2020Long-dated call ratio backspread with implied volatility as one procedure
- 2020Weekly credit spreads: screen the week, then stop behind support