From the October 01, 2011 issue of Futures Magazine • Subscribe!

Exploiting market maker tools to profit

"Calling on Apple" (below) lists September 2011 Apple Inc. call options. It analyzes strike prices from $340 to $420 on June 29, 2011 when the stock’s price is $334.04. Dollar variations from predicted values extend from plus $21 to minus $18, a range that would appear to leave room for spreads between several strike prices.

For options spreads, the slope or delta value at each strike price is required information because the slope indicates the expected price change in an option’s price given a change in the underlying. For example, the slopes shown for Apple strike prices of $360 and $370 are 0.304 and 0.212, respectively. A spread trade involving the sale of the $360 strike at a $640 premium theoretically would be matched with a purchase of 0.304/ 0.212, or 1.43 calls at the $370 strike.

Differences from the predicted price curve for September Apple calls on June 28 and 29 suggested that the long 370/360 call spread (long 370, short 360 call) could be a profitable trade. The price variation chart in "Calling on Apple" illustrates the area of lower-volume trades from the $420 strike to $370, at which the underlying stock price at $334.04 is 90% of the strike price. For higher strikes, the general market may be hesitant to trade out-of-the-money calls, permitting market makers to complete the needed pricing by staying close to theoretical models that are close to the LLP price curve.

Results from the Apple spread trade are known the following day, when on June 30 the option premiums change from $640 to $630 for the $360 strike, and from $380 to $415 for the $370 strike price. The $45 net gain does not include the extra income that would result from equalizing the two slopes.

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