Call Spread Sale in Excel

A call spread sale is a type of options strategy that involves selling a call option and buying another call option with the same expiration date but a higher strike price. This strategy is used when the trader expects a moderate decline in the price of the underlying asset, such as a stock or an index.

The main advantage of a call spread sale is that it generates income from the premium received by selling the call option. The premium is the amount of money that the buyer pays to the seller for acquiring the right to buy the underlying asset at a certain price before a certain date. The premium also reduces the risk of owning the underlying asset, since it limits the maximum loss to the net premium received.

The main disadvantage of a call spread sale is that it caps the maximum profit to the net premium received, which may not be enough to offset any potential losses from owning or shorting the underlying asset. For example, if an investor sells a call option with a strike price of $50 and buys another call option with a strike price of $55, both expiring in one month, and both are out-of-the-money (OTM), meaning that their intrinsic values are zero, then their maximum profit is $500 ($500 – $0 – $500), which is equal to their net premium received ($500). However, if their positions are assigned (the buyer exercises their right to buy) at $50 or lower, then they will lose more than their net premium received.

A call spread sale can be classified into two types: bull call spread and bear call spread. A bull call spread involves selling an OTM call option and buying another OTM call option with a higher strike price but with the same expiration date1. A bear call spread involves selling an OTM call option and buying another OTM call option with a lower strike price but with the same expiration date. The difference between these two types is that they have opposite directional expectations for the underlying asset.

A bull call spread is used when an investor expects a moderate rise in the price of an underlying asset1. A bear call spread is used when an investor expects a moderate decline in the price of an underlying asset. Both strategies have similar risk-reward profiles, but they differ in how they are affected by changes in volatility and time decay.

Volatility refers to how much fluctuation there is in the price of an underlying asset over time. Time decay refers to how much value erodes from an option as it approaches its expiration date. Generally speaking, higher volatility increases both volatility and time decay for both bull and bear spreads, while lower volatility decreases both volatility and time decay for both bull and bear spreads.

Therefore, when volatility is high, both bull and bear spreads tend to have higher premiums received by selling options than when volatility is low. However, when time decay accelerates due to high volatility or low time value (the portion of an option’s value that remains after subtracting its intrinsic value), then bull spreads tend to lose more value than bear spreads before expiration.

For example, suppose that XYZ stock has an implied volatility of 40% for one month options expiring on January 31st. If XYZ stock rises from $50 to $60 before January 31st, then both bull and bear spreads will lose value due to high volatility and time decay. However, if XYZ stock falls from $50 to $40 before January 31st, then only bear spreads will lose more value than bull spreads due to high volatility.

Basic Theory:

A call spread sale consists of two main components: selling a call option (short call) and buying a call option (long call). The short call generates income for the trader, while the long call serves as a hedge to limit potential losses. The strategy profits when the underlying asset’s price remains below the higher strike price of the long call at expiration.

Procedures:

1. Identify the Underlying Asset and Options Contracts:
   • Choose the underlying asset for which you want to implement the call spread sale.
   • Select call options with the same expiration date but different strike prices.
2. Execute the Call Spread Sale:
   • Sell a call option with a lower strike price (short call).
   • Simultaneously buy a call option with a higher strike price (long call).
3. Calculate Maximum Profit, Maximum Loss, and Breakeven Points:
   • Determine the maximum profit, maximum loss, and breakeven points using the strike prices of the short and long calls.
4. Implement in Excel:
   • Utilize Excel formulas to model the call spread sale and calculate relevant metrics.

Scenario:

Let’s consider an example with the following options contracts:

• Short Call:
  • Strike Price: $50
  • Premium Received: $3
• Long Call:
  • Strike Price: $55
  • Premium Paid: $1.5

Calculations in Excel:

1. Income from Short Call (Max Profit): =Premium Received * Number of Contracts
   • In Excel: =$3 * 1 = $3
2. Cost of Long Call (Max Loss): =Premium Paid * Number of Contracts
   • In Excel: =$1.5 * 1 = $1.5
3. Breakeven Point: =Short Call Strike Price + Premium Received
   • In Excel: =$50 + $3 = $53
4. Maximum Loss: =Long Call Strike Price - Short Call Strike Price - Premium Received + Premium Paid
   • In Excel: =$55 - $50 - $3 + $1.5 = $3.5

Result:

• Maximum Profit: $3 (Income from Short Call)
• Maximum Loss: $1.5 (Cost of Long Call)
• Breakeven Point: $53
• Net Result: This strategy profits if the underlying asset’s price remains below $53 at expiration.

Other Approaches:

1. Adjusting Strike Prices:
   • Customize strike prices based on your risk tolerance and market outlook.
2. Varying Expiration Dates:
   • Experiment with different expiration dates to tailor the strategy to your time horizon.
3. Consideration of Implied Volatility:
   • Factor in implied volatility to assess the potential profitability of the strategy under varying market conditions.