My question is related to finance, but really it’s (I think) a fairly straightforward math problem.
There are two opposing (inverse) investment vehicles with the same equations that solve their Max Risk / Max Reward values, except the solutions to the two variables (Max Risk / Max Reward) are flipped depending on the scenario. To compute them, you have to identify which is which to determine which equation should be used. But it seems to me (intuitively) that since they’re just inversed it should be possible to write a single equation that would calculate the values regardless of which one is is a credit spread or a debit spread. See the following:
DISH 3/17 28c DISH 3/17 30c current value: 254.99 current value: 163.75 original cost: 273.75 original cost: 186.24 strike: 28 strike: 30
When placing a debit spread, the risk amount is the debit price plus any transaction costs. The potential reward equals the spread width minus the debit price, less transaction costs. For example, let’s look at a spread in DISH consisting of the purchase of the 28-strike call for $273 and the sale of the 30-strike call for $186. Resulting in a trade credit of -$87. (debit of $87)
In this case, the risk amount would be $87 per contract. The potential reward would be the difference between the strikes ($2) x 100 ($200) plus the negative credit (or minus the debit) amount (-$87) = $112 per contract (less transaction costs).
Bought DISH 28c, Sold DISH 30c, Equations:
- Credit: sold.cost($186) – bought.cost($273) = -$87
- Max Risk (Cost): Credit(-$87)
- Max Reward: sold.strike($30) – bought.strike($28) = $2 * 100 = $200 + Credit(-$87) = $112
- Current Reward: Credit(-$87) – sold.value($163) + bought.value($254) = $4
- Percent Return: (Current Reward($4) / Max Reward($112)) * 100 = 3%
To determine the risk amount of a credit spread, take the width of the spread and subtract the credit amount. The potential reward on a credit spread is the amount of the credit received less transaction costs. To illustrate, let’s say you sold the DISH 28-strike call for $273 and bought the DISH 30-strike call for $186. Resulting in a trade credit of $87. (debit of -$87) To calculate the risk per contract, you would subtract the credit received ($87) from the difference between the strikes ($2) x100 ($200) = $112 per contract (plus transaction costs). Your potential reward would be your credit of $87 per contract (less transaction costs).
Bought DISH 30c, Sold DISH 28c, Equations:
- Credit: sold.cost($273) – bought.cost($186) = $87
- Max Risk (Cost): sold.strike($28) – bought.strike($30) = -$2 * 100
= -$200 + Credit($87) = -$112
- Max Reward: Credit($87)
- Current Reward: Credit($87) – sold.value($254) +
bought.value($163) = -$4
- Percent Return: (Current Reward(-$4) / Max Reward($87)) * 100 = -4%
How can I solve for Max Risk / Max Reward variables in both scenarios without having to flip the equations used?