74 Part 2
In practice, both strikes of the call or put spread are usually placed out-of-
the-money. The key to all these spreads is the option that is at, or nearest
to, the underlying. We will discuss each of them.
In addition, by spreading one option against the other, you are also
spreading cost against cost, so if one option is dear, then it is financed
by another that is dear. You also minimise your exposure to the Greeks. I
repeat: you minimise your exposure to the Greeks.
The profit/loss calculations that form the basis of these spreads can be
applied to any underlying in stocks, bonds, commodities or FX. For the pur-
pose of illustration, a set of options on a stock index is given in Table 8.1:
SPDR at 115.22
45 days until June expiration
Contract multiplier of $100
Table 8.1 SPY options
107 109 111 113 115 117 119 121 123
5.05 3.80 2.60 1.70 1.00 0.55
1.75 2.15 2.60 3.10 3.90 4.80
*Long call spread
(‘Spider’) is currently trading at 115.22. You may wish to pur-
chase the 117 call to profit from an upside move. It’s close to expiration,
time decay is costly, and the implied volatility is higher than it has been
recently, so an expenditure of 2.60 × $100, or $260 may seem too great.
You could sell the 119 call for 1.70 at the same time as you buy the 117
call, for a total debit of 0.90 or $90. Your short call then effectively finances
the purchase of your long call, and minimises your exposure to the Greeks.
S&P 500 ETF Trust. The options trade at Chicago’s CBOE. The SPDR is a mutual fund
based on the S&P 500. Just think of it as the S&P 500. The current open interest on this
options contract is a massive 13 million. In other words, everybody and his uncle trade
it. Because it’s 1/10th the size of the Spu’s, it’s affordable.