I am new to options and studying various option strategies. I have a doubt regarding bull call spread.
Support I am bullish about a stock/index and I buy the call option. From what I understand, one way to hedge my risk is to sell a OTM call in case the market doesn’t go in favorable direction. I have seen people creating 2 legs for this and doing it together in general.
However what if I buy the call option and if the market doesn’t move in my favor (let’s say after few days) and then I decide to sell OTM call instead of doing it along with buying the call then is it any different? It should still be a valid bull call spread but my question is how is it different in terms of change in profits/losses, volatility, time decay compared to the typical 2-leg scenario where both legs are created together. In other words, how does creating the 2nd leg later impact the overall strategy in favorable or unfavorable way, if any.
All legs in Option strategies are ment to be executed together. There is no point in executing one leg first and other leg later.
Taking your example of executing Long Call position first and then executing Short position when market has moved against you, by the time the market has moved against you the Long position would already been in losses, whereas if you had Short position, the loss in Long position would’ve been somewhat covered by profit in Short position, limiting your overall loss.
You can learn more about Options and Option strategies on Varsity, you will get proper understanding of what to do and what not to do.
Thanks for clarification. Just for argument sake - if the market is moving in unfavorable situation (for call buy), wouldn’t selling OTM would still be a good idea since the chances of sold call option might expire worthless considering the market is moving in opposite direction?
Bro how will you know already that market is going to move against your trade and even if it is moving in opposite direction, will you know how long the move is going to continue??
Say market is moving down and you Short Call Option… if the market reverses the potential for losses is unlimited in Short position. One cannot predict want is going to happen next, it is next to impossible.
Sorry I guess I didn’t make my point clear. I get that the short call could potentially result in unlimited losses and neither I was trying to predict the future … but my point was that I already have a long call option (as per original discussion) so it’s not really naked shorting.
Aahh my bad, then you can take Short position… if market goes down you will be in profit if it doesn’t your losses will be capped as Long position will work as hedge.
Long options are already hedged. Whenever you buy options your losses are already predefined. So selling an OTM call is not a hedge for long call.
No it is not. Option buying is useful if you are expecting a strong direction move in short span of time. This is because of a theta decay buyer will suffer if time elapses without any significant move. When you sell OTM option, it limits your gains after a certain price level even if market moves beyond that level. So basically If you have bought 11700 CE and sold 11900 CE your max profits will stop increasing beyond 11900 & you will get flat payoff. But this is at the moment of expiration.
Situation & payoff is slightly different before expiry. As market moves in your favour, your long option will show profits increasing gradually, but simultaneously your short position will start making losses proportionately as per respective deltas. So at any moment of time your net profits will be less than what it would have been in case of single long position. And hence if you book out before expiry, you will have to book less profits.
Simply put only use of short leg in this case is mostly to counter theta decay in long opt.
And as theta decay is not uniform, you can delay shorting till the time come when theta decay accelerate.
For eg. For weekly options I usually do not short for THurdady, Friday and monday as there is very little theta decay/.
But I will sell from tuesday onwards as theta decay is huge.
Dear Sir, AFA options trading is concerned both are totally different scenarios. Short legs in debit spreads like Bull Call are to counter theta decay only.
In case of credit spreads like Bull Put, long legs are to hedge short leg.
Both spreads are bullish but you need to think about psychology and philosophy behind both spreads,
Bull Put spread - I am bullish. So what is the FIRST trade that came to my mind? Short Puts! Obvious, isn’t it? But I also want to hedge my risk. So I buy farther OTM put. I am net credit. And this net credit or theta is what I wanna earn.
Bull Call Spread - I am bullish. So what is the FIRST trade that came to my mind? Long Call! Obvious, isn’t it? But I will lose theta if market do not move. I iwll be punished even if market move in my favour, just npt that fast and that furious. So I sell some cheap OTM option to compensate for some theta decay (not all). I am overall in debit. Unlike earlier hwere I wanna earn Theta, here theta is my enemy and I wanna earn delta.
Selling put does seem to make more sense in this scenario, it’s just that the idea of “shorting” or “selling” for being bullish is a bit difficult to digest for someone like me who is new to options … but with help from this community, it’ll start coming naturally in some time hopefully.
… but my point was that I already have a long call option (as per original discussion) so it’s not really naked shorting.
So I sell some cheap OTM option to compensate for some theta decay (not all). I am overall in debit. Unlike earlier hwere I wanna earn Theta, here theta is my enemy and I wanna earn delta.