Wednesday, August 31, 2011

Rambling about Bull Call Spread on ROK

NYSE:ROK current price: $61.70

APR 12 BUY TO OPEN 1 CALL @ $35 for US$28.2 = $2,800
    Break Even = $35 + 28.2 = $63.2
        vs
    Current Price of $61.7. Difference = US$1.50

SEP 11 SELL TO OPEN 1 CALL @ 65 for US$1.2 = $1,200
    Break Even = $63.2 - $1.2 = $62
        vs
    Current Price of $61.7. Difference = US$0.3


At expiry,    
        if price is above $65, SEP 11 is called.
            I have to exercise my APR 12 call, need to pay US$35.
            Total paid so far = Break Even = $62
            I will be called SEP 11. Credit $65. Earn $3 * 100 = $300

        if price is below $65, SEP 11 expired worthless.

            If say the price is $57, I will have paper loss of $5.
            By then, the price of next-month's $60 will be around $1. If I sell next month CALL @ $60 for $1, I run into the RISK of $62 (break even) - $60 (called assignment price) - $1 (call premium) = $1 at risk if the price jumps above $60 and I get my call assigned.

            If each month for the next 7 mths (from Oct '11 - Apr '12), I get to sell for $1 credit, Final Break Even Price = $62 - $7 = $55

Disclaimer: I am not promoting an analysis on any stocks. The example on ROK is purely for illustration purpose. I could have used any stocks for this exercise and achieve somewhat similar probability outcome. If you want to use this for real life trade, do so at your own risk.