Fri Sep 29, 2006: Selling Call and Put Spreads (AAPL)

When you expect a stock to remain in a trading range, one option writing strategy that might be attractive is to sell out-of-the-money call spreads and out-of-the-money put spreads.

This approach is similar to selling option strangles (see the commentary: Double Your Option Income: Sell Strangles!) but with spreads your maximum loss is limited.

The highlighted lines in the tables below show the option income available now from selling both a call spread and a put spread on the stock of Apple Computer (NASDAQ-AAPL). The percentages are based on the income divided by the margin deposits required to sell the spreads.

The current price of AAPL is $76.98 per share.

Let's look at what can happen by selling an October 80 call and buying an October 85 call for a net credit of $130 per spread. This call spread is 5 points or $500 wide. If AAPL stays below 80 by expiration day October 20th then both calls will expire worthless and you will have a profit of $130. If it closes above 80 your maximum loss could be $370. For a detailed example of call spreads see the commentary: Sell Call Spreads Instead of Covered Puts?.

At the same time we could sell an October 72.50 put and buy an October 70 put for a net credit of $60 per spread. This put spread is 2.5 points or $250 wide. If AAPL stays above 72.50 by expiration day October 20th then both puts will expire worthless and you will have a profit of $60. If it closes below 72.50 your maximum loss could be $190. For a detailed example of put spreads see the commentary: Sell Put Spreads Instead of Covered Calls?.

Unlike most situations in option trading, with this strategy you can be guaranteed that at least one of your two positions will be completely profitable at expiration, because AAPL cannot be both above 80 and below 72.50 at the same time. So at least one of these spreads will certainly expire worthless.

The breakeven range for this trade is 70.60 to 81.90 because the total income is $190.

Until next time, best of luck with your option investments!