Comparing results of a call spread vs a call and how to manage the call spread after hitting the price target 'too soon'.
TSLA stock has been on a tear the past month, now trying to get above the 1000 level. A little over a month ago I used TSLA to illustrate the benefits of a vertical call spread versus buying an out-of-the-money call. The price target I used was 1000, and I gave it some time, out to July expiration. A month short of that price target TSLA stock has already reached that point.
A month ago I posted about Tesla (when it was $830) and compared a call spread (the July 830/1000) vs the 1000 call because they were similar prices ($55 on the spread, $47 on the call). One of the things you often hear traders talk about when doing a multi-leg trade, is "what if the move happens too quickly, sometimes you wish you had just done something more 'simple'." In this case TSLA hit the target of $1000 a month 'too soon'.
Let's recap the TSLA case to illustrate and then we'll talk about trade management below.
First, here was the original trade comparison, posted on OptionsEye on May 12th:
Using $1000 as a target, here's some trades generated by OptionsAi technology (all based on a 1 lot in options or in the case of stock, 100 shares):
I want to focus on the 830/1000 call spread. It costs $55, and that certainly seems like a lot, but let's focus on the components of that trade. Here are the current prices on those two strikes, expiring July 17th:
This $170 wide spread costs $55, but it is selling a 1000 call at nearly the same price (~$47). In other words, using a spread to target $1000 only costs slightly more than buying the $1000 call outright. And the difference in probability? It's massive. The 830/1000 call spread breaks-even around $885 in the stock, giving it a probability of profit percentage in the 40s. The 1000 call? It breaks-even at ~$1047, giving it only ~27% probability of profit. Well, what about profit potential? The call spread is capped at $1000, what if the stock goes above $1000? The call spread makes up to $115 at that level. The 1000 call would need TSLA to get to $1162 to do the same thing. Are you willing to let $47 ride on that?
I chose to highlight that example because the cost of the spread was so close to the cost of the 1000 call, $55 on the spread vs $47 on the call.
To the trade. With TSLA $1000, at the target, but with a month to go, buying the 1000 call would have worked great. It is now trading $80, a gain of $33 dollars.
But let's compare that to the 830/1000 call spread (long the 830 call, short the 1000 call). It's worth worth $115. A gain of $60!
Now, the next question may be, but now the Call Spread is capped, while the call can keep making money, so the call is better now right? It is true that the call spread is capped, but right now it's only worth $115. That means if TSLA keeps going higher, it can still make another $55 (max value $170). And even if TSLA doesn't go anywhere and is $1000 a month from now, it would still make that last $55.
The 1000 call, on the other hand, currently trading $80, needs TSLA to keep going higher, above $1080 in the next month, just to not lose current profits. And it needs TSLA to get above $1162 to be worth more than the 830/1000 call spread on expiration. For those thinking in theta terms, the Call has decay working against it. The Call Spread... because it is short the 1000 call (which is now at-the-money)... has decay working for it.
Ways To Manage
As far as managing the call spread, it's easier than most think. Be patient and wait to see what TSLA does next. If it keeps going higher this call spread will continue to make money. Even if it goes sideways near 1000, this call spread will continue to make money. AND, if it does start to go lower, you have room. In fact, you can make a stop in the stock below (mentally) at which point the current profits would be at risk at expiration. Here's how: The trade is currently worth $115. That means that in a month, if the stock is above $945, this trade will have made more money than it has right now. (it's intrinsic value is 170 right now, but it's trading 115, meaning it just has to finish above 830+115 to be worth more than it is now) That's a pretty large buffer to the downside where it can be worth even more. And to the upside it guarantees it will be worth more.
That level is inside the expected move so it's good to keep a mental stop if the stock reverses from here. From OptionsAI technology bearish expected move on 7/17 is $873:
I featured a similar thought process on call spreads vs calls in NKLA the other day, you can read that here.
See a part of OptionsAI technology with your own price target and demo trades in AAPL HERE