Options 101: The Risk Reversal

A risk reversal consists of buying an out of the money call and being short an out of the money put, both with the same expiration month.

Risk reversals are used when the investor has a market opinion. For example, if the trader is bullish, another option besides going long the stock, would be to buy an out of the money call option, and simultaneously sell an out of the money put option. The money he receives from the sale of the put option would finance all or part of the purchase of the call options. Then as the stock goes up in price, the call option will increase in value, and the put option will decrease in value.

Options 101: The 1x2 Ratio Call Spread (front spread)

A ratio 1x2 call spread, or front spread, is comprised of 2 legs, both calls at two different strike prices in the same expiration month. Ratio spreads involve buying one option and selling two options with a higher strike price. The most common ratio is 1x2, but any ratio can be used. Ratio spreads can be executed for debits, credits, or even money. Ratio spreads can be very complex, which increases the amount of risk involved.

Trade of the Day: F March/May $17 calendar call spread 13,000x

The Trade

A trader sold 13,000 March $17 calls at $0.24 and bought 13,000 May $17 calls at $0.74 for a debit of $0.50 or $650,000. It's interesting to note that a trader initiated a March/May long calendar spread yesterday too.

Risk/Reward

The max risk and max profit potential for this calendar spread are both limited. The max risk for the long call calendar would be the costs to put on the spread, the debit. The maximum profit potential of this spread would occur if the underlying stock price would move directly to the strike price. Therefore, a large move in the underlying would hurt the spread, an increase in volatility would help, the passage of time would help.

At March expiration, the lower and upper break even underlying price levels are $16.80 and $17.20. At the close today, the underlying finished at $15.95. The 52-week range for F is a low of $9.75 and a high of $18.97. On February 4th, Ford reported a fourth-quarter earnings miss. If F were to reach the $16.50 level and approach the $17 max profit level before March expiration, the trader would have the option to unwind the position and take profits. Or, the trader can roll the short March calls to short April calls and keep the same spread on. Depending on the traders view, he can also roll into a butterfly or a back-spread at very favorable prices.

Ford traded 223,476 contracts today.

According to Google Finance, F had the lowest P/E ratio compared to its competitors TM, HMC, NSANY, DDAIF, and VLKAY.