Stocks & Commodities V. 29:8 (55): Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile

BULL AT A DISCOUNT?

I’ve noticed some bull call spreads trade for less than intrinsic value prior to expiration. Why is that, since it would seem like a good opportunity to buy at a discount compared to an outright call?

What you’re seeing is a function of larger extrinsic or time value in the short, higher strike call compared to the deeper long call. This causes some verticals, in particular those with one strike deep-in-the-money and the other slightly in- or out-of-the-money, appear to be trading at a discount to its intrinsic worth at expiration.

This relationship between the two makes profits harder to come by relative to an outright deep long call position as shares move up. But as expiration grows closer or if shares rally swiftly enough, the reduction in the extrinsic value of your short call will result in the spread expanding toward its maximum profit potential.

As with any spread, verticals can represent a stronger opportunity relative to an outright position. However, the determination of this value is a combination of implied and statistical volatility, market conditions, and a trader’s expectations.

At Optionetics, we would favor a vertical over a long call due to its reduction risks associated with the greeks. But we also stress the value in performing this kind of due diligence when a trader considers a position to reach an informed decision.