Last week, we discussed the coated colts on Apple shares (NASDAQ: AAPL). In the previous article it was noted that the purchase of 100 Apple shares will cost investors at about $ 13,500, which is significant for many.
As a result, some prefer to enjoy "covered calls for the poor." Therefore, today we turn to a diagonal debit spread, which is sometimes used to copy the coated collary at a significantly lower price.
Today's article should help investors better understand the possible options, and more experienced players - offer ideas for future deals.
Leaps options
Leaps are decrypted as Long-Term Equity Anticipation Securities, and are long-term stock assets options. In the English-speaking segment of the Internet, they can also be found under the names of LEAP or Leaps.Leaps options (whose maturity dates are usually vary from one to two years) are used by investors who believe in the long-term potential of basic assets, such as stocks or stock funds (ETF). The attractiveness of Leaps is explained by their lower cost compared with the shares (i.e. they are traded at the prices of option contracts).
However, the Wall Street does not have free cheese. Cheaper - does not mean free. Like all options, Leaps have expiration date to which the "predicted" script should be implemented.
Since it is a long-term investment, participants have quite a long time to assess changes in the value of the basic asset. Nevertheless, the trader may lose all invested capital if the expected movement is not realized by the time of expiration.
Therefore, before moving to Leaps, the investor must clearly designate the scale of hedge or speculation. Long-term options only help to achieve the desired risk ratio and potential profits.
Investors who would like to learn more about Leaps shopping strategies can contact Options Industry Council (OIC) educational websites, CBoe Global Markets or {{{0 | nasdaq}}}.
Diagonal Debit Sprord Apple Shares
- Cost: $ 136.91;
- Annual trading range: $ 53,15-145.09;
- Annual increase: + 71.12%;
- Dividend yield: 0.60%.
First, the trader buys a "long-term" call with a lower cost of execution. At the same time, it sells a "short-term" call with a higher progress, creating a diagonal spread.
In other words, call options (in this case, on Apple shares) have different bargain prices and expiration dates. The trader opens a long position by one option and closes the other to make a profit in the form of a diagonal spread.
This strategy limits both risks and potential profits. The trader sets the position on the pure debit (or cost), which is the maximum loss.
Most traders applying this mechanism are moderately optimistic about the basic asset, i.e. Apple papers.
Instead of buying 100 Apple shares, the trader buys an option "in the money", in which Call Leaps serves as a "surrogate" of AAPL shares.
At the time of writing, Apple shares cost $ 136.91.
At the first stage of this strategy, a trader can buy an option call Leaps "in money" (for example, a contract with a date of expiration on January 20, 2023 and a strike of $ 100). Currently, it is offered at a price of $ 47.58 (the average point of the current population and suggestions). In other words, the ownership of the call option, which expires just in less than two years, will cost the trader at $ 4758 (instead of $ 13,691).
The delta of this option (which shows the value of the expected change in the option price when the value of the base asset is 1 dollar) is 0.80.
Let's go back for example: if AAPL shares will grow by $ 1 to $ 137.91, then the current price will grow by 80 cents. Please note that the actual change may differ depending on other factors on which we will not stop in this article.
Thus, the Option delta is increasing as the contract goes deeper in money. Traders will use such leaps, because as the delta approaches 1, the option dynamics begins to reflect the flow of basic paper. Simply put, Delta in 0.80 will be equivalent to the ownership of 80 Apple shares (unlike 100 with a conventional covered call).
As the second stage of this strategy, the trader sells a short-term call "out of money" (for example, an option on March 19, 2021 and a strike of $ 140). The current premium for this option is $ 4.30 US dollars. In other words, the option seller will receive 430 dollars (excluding commission).
The strategy takes into account two expiration dates, therefore it is quite difficult to express the exact formula of the break-even point of this transaction.
Various brokers or sites can offer their own profit and loss calculators. To calculate the cost of contracts with the highest execution deadlines (that is, Leaps Coles) at the time of expiration of short-term options, a pricing model is required to obtain a "approximate" break-even point.
Maximum transaction potential
The greatest profit can be removed if the cost of the action is equal to the pricing price of the short-term call at the date of its execution.In other words, the trader wants the price of Apple Paper remains as close as possible to the bar of the short-term option strike (in our case - $ 140) as of March 19, 2021, not exceeding it.
In our example, the maximum income theoretically makes up about $ 677 at a price of $ 140 at the time of expiration (excluding commissions and other costs).
How did we come to this meaning? The option seller (that is, the trader) received $ 430 for the option sold.
Meanwhile, Apple shares rose from $ 136.91 to $ 140. This is the difference of $ 3.09 for 1 Apple share (or 309 dollars per 100 shares).
Since the LEAPS long-term option delta is 0.8, the cost of a long option will theoretically increase by $ 247.2 (309 * 0.80). Remember that in practice it may be more or less than this value.
We fold 430 and 247.2 dollars and get $ 677.2.
Thus, not even inserting $ 13691 in the 100 Apple shares, the trader makes a profit anyway.
In other words, the premium that trader is initially getting for the sale of a short-term optional option (i.e. $ 430), in percentage exceeds the return on investment of $ 13,691 in 100 Apple shares.
Ideally, the trader hopes that the short-term call will expire "out of money." Then he can sell a call one after one (while after two years the Leaps contract will not expire).
Position Management
Active position management with the calculation of a diagonal debit spread may cause difficulties from beginner traders.
If on March 16, Apple's share will exceed 140 dollars, the position will bring lower income, since the short-term option will be unprofitable for the seller.
In addition, the trader may feel the need to close the transaction ahead of schedule if the price of Apple takes off, and the short-term call comes in deeply "in money". In this case, the entire transaction is under threat of liquidation, since the trader will begin again or at all will choose an alternative strategy.
With a conventional Cole-covered, the trader may not object to the payment by the option, since it already owns 100 Apple shares. However, in the case of a covered call to the "poor man", the trader does not suit this scenario, since he still does not own AAPL shares.
On March 16, this LEAPS deal will start losing money if the share of Apple shares will fall at about $ 132 or lower. Theoretically, the share price may fall to 0, which reduces the cost of a long-term call.
Finally, we must also remind readers that Leaps "deep in money" options are usually high spreads between the purchase and sale price. Consequently, every time the trader buys or sells such an option Leaps, one should remember the transaction costs.
Read Original Articles on: Investing.com