I've had a most disheartening experience with a spread I had purchased in AMR (AMR) in November at $7.50 to $10. Back in early May, I decided I wanted to get some exposure to this volatile stock. I decided to go for a spread as a more conservative method. Imagine my dismay when I find that the recent run has only brought me to even on a net profit basis! After checking the "greeks," I was even more horrified to find that the difference in delta between the calls is minimal and that the vega even suggests that an increase in volatility will work against me. I could have doubled my money had I just gone with the "naked" long!Could you discuss these additional nuances on your profit potential on a spread? Thanks. -- D.A One of the most frustrating things about trading options, aside from wide spreads and illiquid markets, is when your thesis is right but the option strategy employed yields disappointing results. This question provides a great opportunity to drill further into last week's
Given that AMR had already jumped from $2 in April to $6 in May as the airline averted bankruptcy, it seems perfectly prudent to use a spread in anticipation of only moderate gains over the term. But if D.A. was looking for a quick "double," there was no reason to spread, especially not using November expiration. Instead he could make outright purchases of calls as he suggested, or some other vega-positive strategies such as a "
back spread ," which involves selling in-the-money options while simultaneously purchasing a greater number out-of-the-money options, typically at least at a 3-to-1 ratio, leaving you net long options in terms of quantity. It also creates a position in which your delta (the change in price for every one-point move of the underlying security) increases with the predicted price movement. In this example, the position gets more bullish as the price rises. An important distinction between a volatility play and one based on expectations of fundamental improvement in price is that profits in the former should happen as soon as a large move occurs, while the latter's maximum profit typically won't be realized until the option expiration date. While D.A. would have loved cashing out of some straight long calls for a double, he needed to think about his expectations. The fact is, with AMR now trading at $9.80, his spread looks increasingly likely to end up in the money and achieve maximum profit. But I understand his frustration and worry in needing to wait four months to reap the rewards of his great call. The question he now faces is whether to make some adjustments. He could choose to create a box by buying the November $7.50/$10 put spread. While this would lock in some profits, it would greatly reduce the maximum gain. He could short some stock to create a delta-neutral position, but this would expose him to risk by making him short should AMR continue to trade higher. He could sell a few calls with a shorter expiration to offset the cost of the spread, but this again entails the risks creating a negative delta. The choices go on and on, leading to the choice of doing nothing.