Y! options experts: what do you think of this strategy?
Let’s take GE for example (currently closing price of $7.06):
All options are for Mar 09 expiry (14 days):
1) sell a $5 itm call option @ $2.22
2) buy a $7.50 otm call @ $.56
3) sell a $7.50 itm put @ $.96
4) buy a $5 otm put @ $.18
I know I am collecting a net premium of $2.44, or $2.22 after commission. After that, I’m a little hazy on what kind of scenarios could play out – but I believe that is a very high premium and it would be difficult to lose money on that trade, am I wrong?
astat, I thought my out of the money options might appreciate higher than the itm options. But if they are going to be worthless, then indeed it makes no sense.
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about 1 year ago
Just by GE at 6 or 11, thats a much safer bet either way you know its going up. forget options on that stock.
about 1 year ago
I don’t see how this will work. Say the stock finishes at 7.50. You’ll owe $2.50 on 1) and 2, 3, and 4 will be worth nothing. Similarly if it ends up at 6, 1) and 3) will add up to $2.50 while 2) and 4) will be worth nothing.
Unless you started off more than $2.50 after commission, I don’t see how this will work out.
OP: my comments were for the day the options expire. What you say could certainly happen some time before – because the options prior to expiry have a time value in addition to potentially an in-the-money value. Depending on how others are arbitraging (sp?), yes it is possible that what you bought + premium you initially received > what you sold + commissions.
Personally I’ve never been able to make money doing this, but then again, there’s nothing to envy in my track record. At one time I even got stuck not being able to do a synchronized buy back/sale of my options at the prices I needed them at resulting in not very good results.
Do hypothetical purchases and sales, and track them for a few days and see if you actually would have made money at any time during that period.
about 1 year ago
What you have described is a short box spread.
A box spread is considered an arbitrage spread with a fixed value. In your example since the difference between the two strikes is $2.50 the spread is worth $2.50. You are selling it for $2.22. You can be confident that you will never be able to close the position for less than $2.50 because option market makers and other arbitrageurs will never allow a spread worth $2.50 to sell for more than $2.50.
If you could close your spread by buying it in the future for less $2.50 then someone else would also be able to buy it for less than $2.50 and simply wait until expiration, at which time he would collect $2.50 by buying and selling the stock when the in the money options are exercised. He would have a risk free profit. Option market makers could not stay in business if they gave away money.
< << thought my out of the money options might appreciate higher than the itm options>>>
Nope. A rule called “put call parity” will prevent that from happening. A slightly simplified version of that rule is simply this:
Given a put and a call option on the same underlying stock with the same expiration date and the same strike price,
Strike Price = Stock Price + Put Price – Call Price
or
Call Price = Put Price + Stock Price – Strike Price
If you understand the concept of delta in options, another way of saying the same thing is simply
Call Delta – Put Delta = 1.0.