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I sometimes wonder if my real name is Murphy since I seem to constantly live out his law. Last week, we started tracking a bear call spread strategy using Boeing (BA) in a mock trade. The scenario was that resistance for BA was at $35 and with volatility high; the stock was a good candidate to follow using this strategy. This being the case, we decided to sell the October 35 Call and buy the October 40 Call for a credit of $0.95 per spread. This means that for every spread entered, we bring in a total of $95, less commissions. The price we could have actually received for this trade would likely have been better, as we can usually get in the spread, but for the sake of simplicity we used the actual bid and ask prices.

Murphy being alive and well, the next day after we added this example, BA shot to a high of $37.52. Most traders would have had an exit point below this price, but since this is a mock trade to teach us how a bear call spread works, we will keep tracking the play until expiration. Below is the information for last week and the current numbers for our bear call spread on BA.

October 2, 2001
Price of BA – 34.25
Sell Oct 35 Call @ 1.30  IV-54.63 (based on bid)
Buy Oct 40 Call @ 0.35  IV-64.54 (based on ask)
Total Credit – 0.95 or $95 per contract
Maximum Profit – 0.95
Maximum Risk – 4.05

October 9, 2001
Price of BA – 36.00
Oct 35 Call @ 2.10  IV-65.37 (based on ask)
Oct 40 Call @ 0.25  IV-57.62 (based on bid)
Total Debit to close trade would equal $1.85
Current Loss - $0.90 or $90 per contract

The figures for October 9 are showing what it would cost to exit the trade at current prices. Since we buy at the ask and sell at the bid, we have calculated the IV for each option based on the appropriate sale price. Just like when we enter a trade, we should try to exit a strategy by using prices within the spread.

When calling in the sale to a broker, a trader would want to say something like the following: “Please sell my Oct 35 – Oct 40 bear call spread on BA for a debit of $1.75.” This would tell the broker to work the spread for an extra $0.10. You don’t care which option he is able to get you a better deal on, just that he works the spread for you. It is hard to say how much in the spread to expect, as each broker and each option contract is different. However, more highly traded options can often be worked for nearly 50% of the spread.

Going forward, we will lose nearly all the value in the October 40 call because expiration is less than two weeks away. Time erosion accelerates as expiration approaches on out-of-the-money options. If BA falls below $35, the value of the October 35 call would also fall quickly, but as long as it stays in the money, there will always be intrinsic value. Remember, our breakeven point, not counting commissions, would be at $35.95. If BA closed at this exact price on expiration, the October 40 call would expire worthless and the October 35 call would have intrinsic value of $0.95. Since we sold this option, we would owe this amount, but we received $0.95 when we entered the strategy, so we would break even. So, in reality, if BA stays at its current price until expiration, we would finish about even on this mock trade.

BA got a boost last week when China announced they would buy 30 jetliners from the company. This equates to about $1.6 billion and helped push the stock higher. However, the move upward has halted of late and the stock is off from Monday’s intraday high at $37.64. Volume has fallen sharply and it seems the positive news has played out. This doesn’t necessarily mean the stock will fall sharply, but for our trade to profit, we only need it to fall back to the $35 level.

When trading, we need to have the ability to decipher news and make decisions based on this interpretation. Many of these decisions should be made before the trade is entered, but when new information is available, it is wise to incorporate it into the decision making process. Besides looking at the specific issue we are trading, it is important to look at the market in general. Even a strong stock will fall when the market moves sharply lower, so understanding where the broader market is heading helps make better decisions.

Hopefully, by following how BA’s price moves affects our bear call spread, it will help our readers get more insight about this strategy. Remember, a bull put spread works identically to a bear call spread, but is a bullish strategy.

Here’s to a victory in our war on terrorism and success in your option trading.


Joel Addison
Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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