Front Spread w/Calls

• Buy a call, strike price A
• Sell two calls, strike price B
• Generally, the stock will be below or at strike A

All-Stars only

NOTE: Due to the unlimited risk if the stock moves significantly higher, this strategy is suited only to the most advanced option traders. If you are not an All-Star trader, consider running a skip strike butterfly with calls.

You’re slightly bullish. You want the stock to rise to strike B and then stop.

If established for a net debit, there are two break-even points:

• Strike A plus net debit paid to establish the position.
• Strike B plus the maximum profit potential.

If established for a net credit, there is only one break-even point:

• Strike B plus the maximum profit potential.

You want the stock price exactly at strike B at expiration.

If established for a net debit, potential profit is limited to the difference between strike A and strike B, minus the net debit paid.

If established for a net credit, potential profit is limited to the difference between strike A and strike B, plus the net credit.

If established for a net debit:

• Risk is limited to the debit paid for the spread if the stock price goes down.
• Risk is unlimited if the stock price goes way, way up.

If established for a net credit:

• Risk is unlimited if the stock price goes way, way up.

Margin requirement is the requirement for the uncovered short call portion of the front spread.

NOTE: If established for a net credit, the proceeds may be applied to the initial margin requirement.

After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase (or decrease) in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

For this strategy, time decay is your friend. It’s eroding the value of the option you purchased (bad). However, that will be outweighed by the decrease in value of the two options you sold (good).

After the strategy is established, in general you want implied volatility to go down. That’s because it will decrease the value of the two options you sold more than the single option you bought.

The closer the stock price is to strike B, the more you want implied volatility to decrease for two reasons. First, it will decrease the value of the near-the-money options you sold at strike B more than the in-the-money option you bought at strike A. Second, it suggests a decreased probability of a wide price swing, whereas you want the stock price to remain stable at or around strike B and finish there at expiration.