Q & A. Bull Call Spread with Protection


Your articles are brilliant [thanks, but let's not overdo it], but have you come across this scenario?

I wish to put on a bull call spread, with a long ATM [at the money] put for protection.

Take this scenario, for SPY December 2010s:

60/140 call spread cost: 40 – 3 = 37

60/140 bull put spread; collect -4 + 46 = 41 (how much do I post as collateral for this trade?)  [You must put up the maximum value of the spread, (difference between
the strike prices), but you can use the cash collected
($4,100). Thus, $3,900.  But double-check with your broker.  Some
brokers have strange margin requirements.
If you buy the ATM puts, the margin requirement is reduced.]

With those basic calculations, I have 37 of today's dollars at risk, if SPY should fall below 60. [Don't
ignore the fact that you will lose $100 for every point that SPY is
below 97 (the spread is worth 37 when SPY is 97 in Dec 2010.]

A long ATM 100 strike put costs almost $20 – so paying $20 to protect $37 does not make sense.

Am I being too greedy to want upside potential and protection on the downside?

Covered call or naked put does not offer me the higher returns I am looking for, but it does help on the downside I suppose.

Hello Zack,

I'm glad you like the blog.

Buying ATM puts, especially very long-term puts, is expensive.  There's no getting around that.

No, you are not being greedy.  Upside potential with protection is an intelligent thing to do.  In fact, I use that concept when I buy iron condors.  But – whether it's worth the cost is a decision only you can make.

you buy the call spread, please don't ignore the cost of carrying the
position for two years.  Interest rates may be low, but they are not
zero.  Selling the put spread eliminates that concern but creates other
problems – if you are assigned an exercise notice (before expiration)
on the SPY 140 puts, you must pay $14,000 cash to buy SPY shares. I
know you are bullish, but if SPY does not rally significantly, at some
point the put owner will exercise.  For simplicity, and safety, stay
with the call spread.


you hold until expiration, and SPY finishes between 60 and 100, you
collect $4,000, losing $1,700 plus interest.  At 5% interest, your cost
to own a $5,700 investment for two years is $570.

SPY is above 100, your position is worth more – up to a maximum of
$8,000 (when SPY is 140 or higher).  Your profit depends on your cost. 
If you pay 37 + 20, your maximum gain is 23.  Not bad.  $2,300 minus
interest on an investment of $5,700 is  not bad – but it's not
spectacular.  No you are not being greedy.

do those numbers look to you?  You are using a bunch of cash for two
years – that's not so good.  But if you earn the maximum, that's a nice
result.  This is a comfort zone decision:  You like this trade or you
  But it's definitely a bullish play with limited risk and limited reward.


I'm going to show you an equivalent position – risk and reward are equivalent and this position will be easier for you analyze.

Look at your position on paper and then and sell the Dec10 60/100 box.*  [Don't sell it in the real world, just on paper.]

*A market neutral position:
Sell SPY Dec10 100/60 put spread
Sell SPY Dec10 60/100 call spread
Collect roughly $4,000 (the value of the box at expiration, minus interest to carry).

The resulting position:

Buy SPY Dec10 100/140 call spread.
Buy SPY Dec10 60 put.

Total Cost (at today's closing prices), $17.50.
Maximum loss $17.50 (whey SPY is between 60 and 100)

Maximum upside gain: $22.50  (above 140)
You also have the chance to collect some cash if SPY is under $60.

Do the numbers look ok?  Are you comfortable with that risk/reward profile?  This is clearly a personal choice. If 'yes,' go for it.  If 'no,' there are alternative bullish plays.

CCW and NP

Covered calls and naked puts don't offer the protection
you require.  Writing the 60 call or selling the 60 put is not a good
idea, and you would have to sell puts with a higher strike to earn a
decent profit.  The increased risk, coupled with the high margin, says
that this is not for you (or anyone who believes in limited risk).


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