Swim Lessons: Familiar with the Risk Profile Tool?

Once you’ve learned to use Risk Profile tool in the thinkorswim® platform for single-leg options, you may wish to use it for more complex trades.

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https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Vertical Jump: thinkorswim Risk Profile
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In last week’s Swim LessonsSM article we looked at the power of the Risk Profile tool in the thinkorswim® platform from TD Ameritrade, and demonstrated how it can help you estimate changes in a trade profile given certain changes in risk components such as time and volatility. Our first example used one of the more basic option strategies, the purchase of a call option. But the Risk Profile tool can also be used for more complex multi-leg trades.

Let’s start with a vertical spread—the purchase of a call or put option, paired with the sale of another call or put of the same expiration month, but with a different strike. If you need a refresher on vertical spreads, please refer back to recent articles on the basics of vertical spreads and buying a vertical, and selling vertical spreads (aka “vertical credit spreads”.

The following, like all of our strategy discussions, is strictly for educational purposes only.  It is not, and should not be considered, individualized advice or a recommendation.

Make that Vertical Leap

Building a vertical spread in the Risk Profile tool is about as simple as entering a one-leg order such as a long call—it just takes a couple more clicks. On the Analyze tab, click on the Add Simulated Trade page and enter your ticker symbol. Start by right-clicking on a strike that you would like as part of your vertical spread and then click on “Analyze Buy Trade” or “Analyze Sell Trade,” as shown in figure 1. This will bring up a sub-menu of spread choices. Click on “Vertical” (or whatever is your spread du jour).

Analyze a Vertical Spread

FIGURE 1: ANALYZE A VERTICAL SPREAD.

To analyze a spread, right-click any strike and choose the strategy. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

As an example we’ll analyze the 2320/2315 put vertical credit spread, which is the sale of the 2320-strike put and the purchase of a 2315-strike put. In our example we’re selling the 2320 put and buying the 2315 put for a credit of $0.85 (times the options multiplier of 100 = $85, less transaction costs).

To get the visual display of your simulated trade, under the Analyze tab, click on the Risk Profile subtab (right next to Add Simulated Trades). Here you’ll see the graphical representation of potential outcomes for your trade, as shown in figure 2. Remember, it’s an estimation, based on theoretical values, and trades in the real market might perform differently.

Risk Profile of Vertical Put Spread

FIGURE 2: RISK PROFILE OF A SHORT VERTICAL PUT SPREAD.

The “today” and expiration lines for one 2320-2315 short put spread sold for $0.85. Chart source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Scenarios, and the Numbers Behind Them

The blue line, which represents the profit and loss (P/L) of the trade at expiration, has two kinks in it. Those are the strike prices of the spread. The purple line is the estimation of the P/L of the spread as the price of the underlying changes. For instance, if the underlying were to go to 2330 today (1), the trade would be down about $80. But then if the underlying remained at that level until expiration (2), the trades ends up making $85, as both legs would expire worthless and you’d keep the premium, minus transaction costs.

What the graph demonstrates is how the passage of time helps this trade if the underlying stays above the high strike of 2320. If the underlying drops to 2290 today (3) and stays there till expiration (4), a loss of $200 as of today’s date would become a full loss of $415 by expiration. Why? Because if both strikes finish in-the-money, you’ll be assigned a long stock position at $2,320 per share and you’ll exercise your 2315 put, essentially locking in a $5.00 loss. But you collected an $0.85 credit when you sold the spread, so your net loss would be $4.15, times the contract multiplier of 100, or $415, plus transaction costs.

And remember from last week’s Swim LessonsSM article, you can view the risk profile on other dates prior to expiration, and at other levels of volatility by using the Lines and Step buttons.

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Please note that the examples above do not account for transaction costs or dividends. Transaction costs (commissions and other fees) are important factors and should be considered when evaluating any options trade.  Transactions cost for trades placed online at TD Ameritrade are $6.95 for stock orders, $6.95 for option orders plus a $0.75 fee per contract. Orders placed by other means will have higher transaction costs. Options exercise and assignment fees are $19.99.

Spreads and other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return.  These are advanced option strategies and often involve greater risk, and more complex risk, than basic options trades.

Probability analysis results are theoretical in nature, not guaranteed, and do not reflect any degree of certainty of an event occurring.

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Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

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