Option Strategies Details
Buy one ATM Call and sell at least two OTM Calls
1. Speculate on decreasing volatility and a neutral to small increase in price
Down
Neutral to up a little
For a 1xN Call Frontspread: Strike Price of Short Calls + (Width of Spread / (N-1)) + Credit Received
Theoretically unlimited minus the credit received for the Call Frontspread
same as Max Contract Loss
Call Frontspread
Other names
You sell at least two (2) OTM Calls and buy one ATM Call
Description
A trader who wants to speculate on a decrease in volatility and a neutral to small increase in price can open a Call Frontspread. The trader receives a small credit for opening the position.
Suppose stock XYZ is trading at $99. You forecast a decrease in volatility and a neutral to small increase in XYZ price.
You open a 1x2 $100 / $102.5 Call Frontspread (buying the $100 Call for a $2.45 debit and selling two (2) $102.5 Calls for $1.50 each) for a $0.55 credit to express this view. Your breakeven low XYZ price at expiry is any price below $100 (since you entered the position for a credit and all contracts would expire worthless). The high breakeven price is more complex to calculate but adheres to this formula:
Strike Price of Short Calls + (Width of Spread / (N - 1)) +/- Credit Received/Debit Paid
Where N is the number of Short Calls whose credit is used to buy the Long Call.
The high breakeven for this Call Frontspread is $102.5 - ($2.5 / (2-1)) + $0.50 = $105.50. However, since the time component of your trade plan may not since the time component of your trade plan may not extend all the way to expiration you should be prepared to to close at a variety of XYZ prices as the market value of your 1x2 $100 / $102.5 Call Frontspread changes.
The max loss on this position at expiry is theoretically infinite, since XYZ price can increase indefinitely above the high breakeven. The max gain of a Call Frontspread occurs at expiry if XYZ price increases to the exact Short Call strike, where you would make the width of the spread plus the credit received ($102.5 - $100 + $0.50 = $3.00 in this example). Since the loss on a Call Frontspread is theoretically unlimited, this structure carries a high "risk of ruin". The unlimited loss can be mitigated by buying a further OTM Call(s), which morphs this structure into a Long Call Broken Wing Butterfly; unfortunately, this turns the trade into a debit transaction rather than a credit transaction and removes the gains associated with an XYZ price decrease.