Option Spread Strategy

My Option Spread Strategy is implemented by purchasing a call option and selling a call option with a higher strike price and the same expiration date. The purchase and sale of the call option can be done simultaneously or you can ‘leg’ into the spread by purchasing a call option and selling a call option at a later date. The Option Spread Strategy differs from my Option Income Strategy. The Option Spread Strategy is implemented with options that have the same expiration date whereas the Option Income Strategy generates monthly income by purchasing a LEAPS option or stock and selling a one month option to generate income.

Let’s take a look at a recent spread trade I took to illustrate the risk/reward profile of this strategy. My brokerage confirmation below show that I purchased 10 of the Intuitive Surgical symbol ISRG April 250-Strike calls at an average price of 80.11 and simultaneously sold 10 of the ISRG April 280-Strike calls at an average price of 54.61. These options expire in less than a month. ISRG stock was trading at 330.60 when this spread was initiated so both the 250-Strike and 280-Strike calls were in-the-money options.

The Call Option Spread Analysis Table below displays the reward/risk profile for this trade. The first row of the table is labeled ‘% Change’ and assumes various percent changes in ISRG stock at option expiration from a 15% increase in price to a -15% decline in price. The second row is labeled ‘Stock Price’ and is the ISRG stock price that corresponds to the percentage change on the row above. The seventh row labeled ‘Spread Profit’ displays the overall dollar net profit/loss for the spread that corresponds with the stock price in Row 2. And the last row displays the % return for this spread trade.

The analysis shows that this spread trade provides profits if ISRG stock goes up in price, remains flat or is down at option expiration in one month. If ISRG stock remains flat at 330.60 at option expiration, a 4.5 point or $450 profit will be realized (circled). This translates to a 17.6% return on the $2,550 cost of the spread. Any increase in ISRG stock at option expiration would also result in a $450 profit and a 17.6% return. ISRG stock could also decline 15% to 281.01 and this trade would still produce a $450 profit.

The profit potential for spread trades is limited once the stock increases above the strike price of the call option sold. In this example our profit is limited to $450 regardless of how high ISRG stock increases above 280.0 at option expiration. I chose to buy and sell in-the-money options as they offer more downside protection if ISRG stock declines in price and at the same time offer an excellent monthly return. ISRG stock would have to decline more than 50 points at option expiration before a loss would be incurred.