how do I calculate rate of return on call options that are spread
Outside of software that can calculate the returns:  You could calculate your possible returns on that leap spread as you ordinarily would, then place the return results of that and the return results for the covered call position side by side for any given price level of the stock you calculate, and net them out. (Netting out the dollar amounts, not percentage returns.)  Not a great answer, but there ya go. Software like OptionVue is expensive You don't necessarily have to use a LEAP to do a spread. Since you are doing a covered call, I'm assuming that you would be comfortable with having that call exercised and you are bullish on the stock. So doing a spread trade with the short call option would essentially be capping your maximum profit without risking the obligation to sell the stock below market value.  An example for the payoff from a bull call spread: long lower strike call, short higher (covered) strike call can be found here
So far the answer is: observe the general direction of the market, using special tools if needed or you have them available (.e.g. Bollinger bands to help you understand the current trend) at the right time per above, do the roll with stop loss in place (meaning roll at a pre-determined max loss), and also a trailing stop loss if the roll works in your favor, to capture the profits on the roll. This trade was a learning experience.  I sold the option at $20 thinking I'd get back in later in the day with the further out option at a good price, as the market goes back and forth.  The underlying went up and never came back.  I finally gritted my teeth and bought the new option at 23.10 (when it would have cost me about 20.20 before), i.e. a miss/loss of $3 on $20. The underlying continued to rise, from that point (hasn't been back), and now the option price is $29. Of course one needs to make sure the Implied Volatility of the option being left and the option going to is good/fair, and if not, either roll further out in time, nearer in time, our up / down the strike prices, to find the right target option.  After doing that, one might do the strategy above, i.e. any good trade mgmt type strategy:  seek to make a good decision, acknowledge when you were wrong (with stop loss), and act. Or, if you're right, cash in smartly (i.e. trailing stops). "Their algorithm may be different (and proprietary), but how I would to it is to assume that daily changes in the stock are distributed normally (meaning the probability distribution is a ""bell curve"" - the green area in your chart).  I would then calculate the average and standard deviation (volatility) of historical returns to determine the center and width of the bell curve (calibrating it to expected returns and implied volaility based on option prices), then use standard formulas for lognormal distributions to calculate the probability of the price exceeding the strike price. So there are many assumptions involved, and in the end it's just a probability, so there's no way to know if it's right or wrong - either the stock will cross the strike or it won't." To Chris' comment, find out if the assignment commission is the same as the commission for an executed trade. If that does affect the profit, just let it expire.  I've had spreads (buy a call, sell a higher strike call, same dates) so deep in the money, I just made sense to let both exercise at expiration. Don't panic if all legs ofthe trade don't show until Sunday or even Monday morning. Something like cost = a × avg_spreadb + c × volatilityd × (order_size/avg_volume)e. Different brokers have different formulas, and different trading patterns will have different coefficients. "No.  The more legs you add onto your trade, the more commissions you will pay entering and exiting the trade and the more opportunity for slippage.  So lets head the other direction.   Can we make a simple, risk-free option trade, with as few legs as possible? The (not really) surprising answer is ""yes"", but there is no free lunch, as you will see.  According to financial theory any riskless position will earn the risk free rate, which right now is almost nothing, nada, 0%.   Let's test this out with a little example. In theory, a riskless position can be constructed from buying a stock, selling a call option, and buying a put option.  This combination should earn the risk free rate. Selling the call option means you get money now but agree to let someone else have the stock at an agreed contract price if the price goes up.  Buying the put option means you pay money now but can sell the stock to someone at a pre-agreed contract price if you want to do so, which would only be when the price declines below the contract price.  To start our risk free trade, buy Google stock, GOOG, at the Oct 3 Close:   495.52 x 100sh = $49,552 The example has 100 shares for compatibility with the options contracts which require 100 share blocks. we will sell a call and buy a put @ contract price of $500 for Jan 19,2013.   Therefore we will receive $50,000 for certain on Jan 19,2013, unless the options clearing system fails, because of say, global financial collapse, or war with Aztec spacecraft. According to google finance, if we had sold a call today at the close we would receive the bid, which is 89.00/share, or $8,900 total.  And if we had bought a put today at the close we would pay the ask, which is 91.90/share, or $9190 total. So, to receive $50,000 for certain on Jan 19,2013 we could pay $49,552 for the GOOG stock, minus $8,900 for the money we received selling the call option, plus a payment of $9190 for the put option we need to protect the value.  The total is $49,842.   If we pay $49,842 today, plus execute the option strategy shown, we would have $50,000 on Jan 19,2013.  This is a profit of $158, the options commissions are going to be around $20-$30, so in total the profit is around $120 after commissions.   On the other hand, ~$50,000 in a bank CD for 12 months at 1.1% will yield $550 in similarly risk-free interest.   Given that it is difficult to actually make these trades simultaneously, in practice, with the prices jumping all around, I would say if you really want a low risk option trade then a bank CD looks like the safer bet.  This isn't to say you can't find another combination of stock and contract price that does better than a bank CD -- but I doubt it will ever be better by very much and still difficult to monitor and align the trades in practice." "A covered call risks the disparity between the purchase price and the potential forced or ""called"" sale price less the premium received. So buy a stock for $10.00 believing it will drop you or not rise above $14.00 for a given period of days. You sell a call for a $1.00 agreeing to sell your stock for $14.00 and your wrong...the stock rises and at 14.00 or above during the option period  the person who paid you the $1.00 premium gets the stock for a net effective price of $15.00. You have a gain of 5$. Your hypothecated loss is unlimited in that the stock could go to $1mil a share. That loss is an opportunity loss you still had a modest profit in actual $. The naked call is a different beast. you get the 1.00 in commission to sell a stock you don't own but must pay for that right. so lets say you net .75 in commission per share after your sell the option. as long as the stock trades below $14.00 during the period of the option you sold your golden. It rises above the strike price you must now buy that stock at market to fill the order when the counter party choses to exercise the option which results in a REAL loss of 100% of the stocks market price less the .75 a share you made.   in the scenarios a 1000 shares that for up $30.00 a share over the strike price make you $5,000 in a covered call and lose you $29,250 in a naked call.Naked calls are speculative. Covered calls are strategic." It's a matter of risk and reward. And its origin goes back to the Black Scholles equation, which is sort of a bell curve of possible outcomes.  Do you see that from $36 to $34 strike, you are putting up over 35% more money to lower your break even by 30 cents?  If I were to bet* $2000, I could buy 3 of the $34 contracts but almost 5 of the $36 strike. If the stock went to $45, I'd be far better off.  *I say 'bet' because simply buying puts or calls, absent any underlying asset, is akin to gambling, not investing. I do it all the time, but with my Vegas money. "Option pricing models used by exchanges to calculate settlement prices (premiums) use a volatility measure usually describes as the current actual volatility.  This is a historic volatility measure based on standard deviation across a given time period - usually 30 to 90 days.   During a trading session, an investor can use the readily available information for a given option to infer the ""implied volatility"".  Presumably you know the option pricing model (Black-Scholes).  It is easy to calculate the other variables used in the pricing model - the time value, the strike price, the spot price, the ""risk free"" interest rate, and anything else I may have forgotten right now.  Plug all of these into the model and solve for volatility.  This give the ""implied volatility"", so named because it has been inferred from the current price (bid or offer). Of course, there is no guarantee that the calculated (implied) volatility will match the volatility used by the exchange in their calculation of fair price at settlement on the day (or on the previous day's settlement).  Comparing the implied volatility from the previous day's settlement price to the implied volatility of the current price (bid or offer) may give you some measure of the fairness of the quoted price (if there is no perceived change in future volatility).  What such a comparison will do is to give you a measure of the degree to which the current market's perception of future volatility has changed over the course of the trading day.   So, specific to your question, you do not want to use an annualised measure.  The best you can do is compare the implied volatility in the current price to the implied volatility of the previous day's settlement price while at the same time making a subjective judgement about how you see volatility changing in the future and how this has been reflected in the current price." One broker told me that I have to simply read the ask size and the bid size, seeing what the market makers are offering. This implies that my order would have to match that price exactly, which is unfortunate because options contract spreads can be WIDE. Also, if my planned position size is larger than the best bid/best ask, then I should break up the order, which is also unfortunate because most brokers charge a lot for options orders. "EDIT quid keenly identified the 1:7 reverse split In May 2017.  In a 1:7 reverse split, your shares are worth 7 times as much per share but you have 1/7 the amount of shares.  A share worth $3.78 now was worth (all else being equal) $0.54 a month ago.   So a call with a $2.50 strike a month ago was well out-of-the-money, and would now be the equivalent of a call with a $17.50 strike.  A $17.50 call with a $3.78 underlying (or a $2.50 call with a $0.54 underlying) would reasonably be worth only 5 cents. So I now suspect that the quote is a stale quote that existed pre-split and hasn't been adjusted by the provider. OLD ANSWER I can find no valid reason why those calls would be so cheap.  The stock price has been trending down from its onset in 2000, so either no one expects it to be above $2.50 in a month or it's so illiquid that there's not any real data to evaluate the options.  They did pay some massive (30%) dividends in 2010 and 2012, they've been hemorrhaging cash for the past 4 years at least, and I have found at least on ""strong sell"" rating, so there's not much to be optimistic about.  NASDAQ does not list any options for the stock, so it must be an OTC trade.   With an ask size of 10 you could buy calls on 1,000 shares for $0.05, so if you can afford to lose $50 and want to take a flyer you can give it a shot, but I suspect it's not a valid quote and is something that's been manufactured by the option broker." I think you're missing the fact that the trader bought the $40 call but wrote the $45 call -- i.e. someone else bought the $45 call from him.  That's why you have to subtract 600-100.  At expiration, the following happens: So $600 + -$100 = $500 total profit. Note: In reality he would probably use the shares he gets from the first call to satisfy the shares he owes on the second call, so the math is even simpler: Yes. It seems to me you got it right.  On my site, Stock Options Cafe, my last post was an illustration of a bullish call spread. In this case, I bought a 50 call, and sold the 60 call. This is a debit order as I was paying money, not collecting a new premium. Ok, so disregarding passivity, could you help me through a simplified example?   Say I only had two assets, SPY and TLT, with a respective weight of 35 and 65% and I want want to leverage this to 4x.  Additionally, say daily return covar is:  * B/B .004% * B/S -.004% * S/S .02%   Now, if I read correctly, I should buy ATM calls xxx days in the future.  Which may look like: Ticker, S, K, Option Price, Delta, Lambda  * TLT  $126.04  $126.00  $4.35  0.50  14.5 * SPY  $134.91  $134.00  $6.26  0.55  11.8  ^ This example is pretty close but some assets are far off.   I feel like I'm on the wrong track so I'll stop here.    I just want to lever up my risk-parity. Margin rates are too high and I'm docked by Reg-T. As other uses have pointed out, your example is unusual in that is does not include any time value or volatility value in the quoted premiums, the premiums you quote are only intrinsic values.  For well in-the-money options, the intrinsic value will certainly be the vast majority of the premium, but not the sole component. Having said that, the answer would clearly be that the buyer should buy the $40 call at a premium of $10.  The reason is that the buyer will pay less for the option and therefore risk less money, or buy more options for the same amount of money.  Since the buyer is assuming that the price will rise, the return that will be realised will be the same in gross terms, but higher in relative terms for the buyer of the $40 call.   For example, if the underlying price goes to $60, then the buyer of the $40 call would (potentially) double their money when the premium goes from $10 to $20, while the buyer of the $30 call would realise a (potential) 50% profit when the premium goes from $20 to $30. Considering the situation beyond your scenario, things are more difficult if the bet goes wrong.  If the underlying prices expires at under $40, then the buyer of the $40 call will be better off in gross terms but may be worse off in relative terms (if it expires above $30).  If the underlying price expires between $40 and $50, then the buy of the $30 will be better off in relative term, having lost a smaller percentage of their money. "First, your professor should learn proper grammar. Should be, ""Why **do**....""  Second, it looks like you're dealing with synthetic securities. You can create a synthetic T-Bill by doing a combination of long/short calls/puts.  But ignore all that. Just think about this without the technical jargon. We know that the risk free rate is typically what T-Bills are yielding right? And we know that since options are inherently more risky than US government debt, investors will demand a higher interest rate to compensate them for the risk. So, as the risk free rate increases, the value of a call will move the same direction, otherwise investors would stop dealing with call options and would instead buy safer, less-risky ""riskless"" investments.  It's not really an options question, just one of basic finance, risk, understanding of interest rates, etc."