We have demonstrated that vertical option spreads have intrinsic
value, and that we can roughly determine their value by comparing
stock price to strike prices. There is another relationship
that can help investors determine value. That is the relationship
that exists between corresponding vertical option spreads.
When we use the term corresponding we mean the same month, the
same strikes in the same stock. The only difference is between
calls and puts. For example, the XYZ Sept. 30 35 vertical
call spreads corresponding option spreads would be the XYZ
Sept. 30 35 vertical put spread. Similarly, the ABC June 70
80 put spreads corresponding option spreads would be the
ABC June 70 80 call spread.
The importance of understanding the relationship of corresponding
vertical option spreads
is that the sum of a vertical call spread
and its corresponding vertical put spread is going to be equal
to the difference between the two strikes.
If the April 30 35 call option spreads trades at $2.00, then
the April 30 35 put spread will be worth $3.00. Lets review
this. The difference of the two strikes is $5.00 and the cost
of the call spread is $2.00. That means the cost of the put
option spreads will be $3.00. The chart below is a floor traders
pricing sheet that shows where individual options are trading
and what they are worth based on each traders individual inputs.
From this we can calculate the price of any of our option spreads.
Pick any vertical spread. Now, calculate the value of a vertical
call spread or a vertical put spread. Once youve done that,
calculate the value of its corresponding vertical spread. Add
the two option spreads
together and see if that sum is equal
to the difference between the two strikes. Perform the calculations
several times on different vertical spreads. Try it on $5, $10
and even $15 spreads.