Followup on DOTM bull call spread and DITM bull put spread

Thanks so much, Kenneth.  In fact, I don't believe we truly are on opposite sides of the discussion; I believe, rather, that our methodology or understanding or practice may differ.  My position (opinion) remains as it was all along: that OTM bull call strategies are the opposite of ITM bull put strategies, both from the point of view of debit vs. credit, and the deltas being positive vs negative, respectively.  Now, to address some participants' assertion that they are "the same," because they complement each other (call delta 0.01 vs. put delta -0.99=1) is not what my argument is all about.  My position has been all along that in an OTM bull call spread with a tiny delta, the underlying stock would have to make an enormous move to the upside for that delta to respond, and for the spread to increase in price, and therefore be favorable to the buyer; while a similar enormous move to the upside on the ITM put spread would substantially decrease the cost of the put spread in favor of the seller, because of the delta near -1, that implies an almost 1:1 move of the options in relation to a move in the stock.  Both positions are bullish.  The call spread costs very little to enter, true, but would require too high a move to be influenced positively; while the opposite is true for the put. 

Whether my understanding of deltas (and thetas, in this case because of the very short expiry) is supported by the other participants in this debate is irrelevant.  This has been a hypothetical position all along, as I repeat, I would never select a front-month expiry for such positions, and I almost never, ever buy OTM calls.  My own methodology, if I wish to buy calls, especially OTM calls, would be to go very far off into the future to allow them time to fulfill their promise.  I'm generous that way.  As stated previously, my own preference in regards to puts is to do OTM naked puts or bull put spreads, but OTM (at a price less than the current stock price).

My hypothetical positions on AAPL, the subject of this debate, have been placed as a virtual trade on a great new platform that is currently a private beta, going public in the near future (preferred browsers include Chrome/Safari/Firefox).  To see my two spreads dance to the music in real time, please click on http://www.tradeclique.com/trader/yaelt#yael.

Another reminder of my preferences is that I generally do not wait for expiration.  I got burned badly in the 1999-2000 dot.com.  Whether it costs more or less in commissions is irrelevant to my peace of mind.  In the hypothetical ITM bull put spread above, since it was placed with a view that AAPL would make a substantial move to the upside by the Sep. 12 unveiling of a new iPhone, my preference would be to close down my put spread as soon as it presented a "significant" profit. I put that in quotations because I cannot tell you what I would consider significant, as to time to expiry is so short.  However, again, hypothetically, since I received a credit of $1800 for this trade, I might consider buying it back to close at, say, $1200 or so, being quite delighted with a profit of $600 in a few days' time (we placed this hypothetical trade around the beginning of Sep.).

Delta, the positive and negative

I came across a misconception about the deltas for puts and calls.  Someone put forth that a Sept. expiry Bull Call Spread on AAPL was the same as a Sept. expiry Bull Put Spread with similar strike prices.  In fact, the two strategies are diametric opposites.  That is because calls and puts do NOT have the same deltas, even when accounting for the fact that put deltas are represented by a negative number.  So, the AAPL Sept. 710 call has a delta of .0159 and the Sept. 730 call has a delta of .0000.  Since a Bull Call Spread is a debit spread, the cost for this spread is tiny, $.10 x .02=$.08 per contract, or $8.  The same strikes for the AAPL Sept. puts are 710 delta of -.9786 and the 730 put delta is -.9942.  Since a Bull Put Spread is a credit spread, the credit received would be $18.50 on a $20 spread, i.e., $1850 credit for every $2000 margin (but the "real" or effective margin is only $150=2000-1850). 

But, and this is a HUGE but -- with September expiry, you are giving no time at all for the stock to move.  Sept. expiry has an enormous theta influence (meaning time erosion).  If you buy the Bull Call Spread, it would cost you nearly nothing ($0.08 or $8 per contract), but the likelihood of that spread rising are almost nil, zero, zilch.  You know why?  Because the delta is 0.  The delta determines how much the option will move for every $1 move in the underlying stock.  With a delta of 0 and only 3 weeks to expiry, you would need a miracle for your $8 to go anywhere.  Of course, $8 is not a lot of money, so you may want to play with it.  But that would represent the true analogy to a lottery.

As for the Bull Put Spread, even though the credit is enormous, the Sept. expiry still poses a problem because of its short nature.  Yes, the deltas are huge (and are represented with a negative sign), which imply just about a 1:1 move of the options for every $1 move in the stock, but again, you are giving a very short time for the stock to do anything.  Very risky.

I am in the process of writing a book on this.  Stay tuned, if you're at all interested

Time Value vs. Intrinsic Value

Recall that options come in two varieties: Calls and Puts.  Both calls and puts can be bought or sold.  That's a total of four possible moves, but within those four moves are innumerable possible permutations.  For the sake of this very simple explanation, let's focus on what is meant to Time Value and Intrinsic Value.

First, Intrinsic Value.  As the term suggests, intrinsic means inherent, built-in, real value.  Let's consider a call option on Apple Computer (AAPL).  The stock is currently trading at about $350.  If you buy a call option at a $320 strike price expiring in May 2011, that means you are buying the right to buy AAPL at $320 on or before May 20, 2011.  For that right, you would pay $33.60 on the ask (you buy at the ask and sell at the bid).  For 1 contract, the total cost would be $3360.  With the stock currently around $350, that means that a full $30 of the cost of the $320 call is intrinsic value, or in the money (ITM).  You are therefore buying some "real meat," if you will.  You are buying some portion of the stock itself.  The remaining cost of the option ($33.60-$30.00=$3.60) is Time Value. 

All options, both calls and puts, have what is known as intrinsic value and time value.  Time value is that portion of the option that erodes over time.  It is much cheaper, dollar-wise, to purchase only time value (out of the money OTM) call options, but the risk is greater.  More on that later.  In the case of AAPL, as above, by spending $3360, you are actually positioning yourself to profit very closely to the movement of the stock itself; if AAPL rises by $1, your call option is likely to appreciate by a similar amount (called the delta - more later).  The delta of ITM call options is significantly higher than deltas for time value call options.