Hey trader,
A vertical spread carries a hard ceiling.
Buy the 40 call, sell the 42, and $2 is everything it can ever be worth.
So you hold for $2. It’s printed right there on the risk graph.
Yet, maybe that’s not such a good idea.
You see, that $2 doesn’t show up when you want it to. It exists on exactly one day of the spread’s life, and only if price is parked above your short strike when the bell rings.
I paid 58 cents for a $2-wide IBIT spread. The next morning it was worth 97 cents.
Climbing from there to $1.50 would take a significant move or a long wait. I’d be carrying full risk the entire time.
So what does that final stretch actually cost to collect?
Let me run the numbers on both sides of it.
The Two Dollars Only Exists on One Day
The structure for this example is the IBIT 40/42 call vertical for the September 18 expiration.
I hold the right to buy at 40 and the obligation to sell at 42.
Say IBIT finishes at 45. The 40 strike holds $5 of intrinsic value. The 42 holds $3.
The difference is $2, and that’s the ceiling. It arrives at expiration and nowhere else.
Before that day, the short 42 still carries extrinsic value working against me. With the stock near 41, the most that spread can be worth is about a buck.
So the first dollar of value comes from price traveling one dollar. The second dollar requires price to clear 42 entirely and then for time to run out on top of it.
Why 70% Is the Number on the Long Side
My exit is cost times 1.7. On 58 cents, that’s 98 or 99 cents.
Notice where that lands.
It’s the same roughly-a-dollar level the spread reaches with IBIT near 41, which is one dollar of travel from where I entered.
I’m collecting the entire first half of the spread’s range on the easy dollar. The back half asks for a move past my short strike plus the calendar.
The same math shows up on a 30-day XLF 57/55 put vertical at 44 cents. I don’t shop for the $2 there either. I look for $1-$1.50 close it.
The Credit Side Runs It Backward
Selling a vertical produces the identical problem in reverse.
On a 58/60 short call vertical in XLF I collect 52 cents against $1.48 of max loss.
My buy-back target is 16 cents, which is 0.52 times 0.7.
Moving from 52 cents down to 16 comes from ordinary decay and ordinary distance.
Moving from 16 to zero is a different animal. That last five or ten cents takes a lot of price movement or a lot of time.
Here’s the arithmetic that settles it. Sitting at 16 cents, I have 16 cents of reward left in front of me and $1.48 still at risk behind me.
That’s roughly nine to one against me for the privilege of finishing the trade. I’d be putting the whole position back on the table to collect the smallest piece of it.
The SPY version prices the same way. I sold a 780/782 call vertical for 49 cents against the call wall and set the buy-back at 10 cents or less, which keeps 39 of the 49.
Time vs Risk
Everything boils down to time and risk.
If I can get 70% of the profits in half the time, why would I wait just as long for that other 30%?
Plus, it’s not just that 30%. I can also lose the 70% I can lock in right then.
That’s the tradeoff you need to consider with every option spread.
Brandon Chapman, CMT
Creator of Ghost Prints
