We have demonstrated that vertical spreads have intrinsic value,
and that we can roughly determine their value by comparing stock
price to strike prices. There is another relationship that can
help investors determine value. That is the relationship that
exists between corresponding vertical spreads.
When we use the term corresponding we mean the same month, the
same strikes in the same stock. The only difference is between
calls and puts. For example, the XYZ Sept. 30 35 vertical call
spreads corresponding spread would be the XYZ Sept. 30 35
vertical put spread. Similarly, the ABC June 70 80 put
spreads corresponding spread would be the ABC June 70 80 call
spread.
The importance of understanding the relationship of
corresponding vertical spreads is that the sum of a vertical
call spread and its corresponding vertical put spread is going
to be equal to the difference between the two strikes.
If the April 30 35 call spread trades at $2.00, then the April
30 35 put spread will be worth $3.00. Lets review this. The
difference of the two strikes is $5.00 and the cost of the call
spread is $2.00. That means the cost of the put spread will be
$3.00. The chart below is a floor traders pricing sheet that
shows where individual options are trading and what they are
worth based on each traders individual inputs.
From this we can calculate the price of any spread. Pick any
vertical spread. Now, calculate the value of a vertical call
spread or a vertical put spread. Once youve done that,
calculate the value of its corresponding vertical spread. Add
the two spreads together and see if that sum is equal to the
difference between the two strikes. Perform the calculations
several times on different vertical spreads. Try it on $5, $10
and even $15 spreads.
It is not necessary to understand the rationale for why this
works at this time. It will be covered in a future Options
University release. For now, it is important to understand that
these spreads are related and the price of one can help you
calculate the price of the other. |
