A “gut spread” might sound like a good name for what happens when we habitually eat too many pizza rolls, but in the financial world, it means something very, very different.
A “gut spread” is a type of option spread, and in this scenario, our options are called “guts” because our put and call options are both in-the-money: our call option’s strike price is below market value and our put option’s strike price is above market value. Being in-the-money also means that these options are a little more expensive than their out-of-the-money kin; they have more intrinsic value, which is also why they’re referred to as “guts.” They’re hearty. If we buy both puts and calls, it’s a long gut spread; if we sell both puts and calls, it’s a short gut spread.
Why? Let’s say there’s a new ocean clean-up company on the scene that we’ve been looking at. They’ve got a unique business model for removing plastic from the water that involves ginormous, floating Roomba-looking things, and we’re not sure whether they’re going to be successful or not. In this situation, we might go with a long gut spread: we’re not sure whether the price of their stock will go up or down, but we’re sure it’s going to do one of the two in a big way, and we’re gonna make some money on it.
On the other hand, let’s consider Taxidonculous, a company that makes tax accounting software. Their stock has been humming along with no major fluctuations for a while now, and we expect that trend to continue. In this case, we might go with a short gut spread: we’ll get paid hefty premiums up front, since our options are in-the-money, and we’ll also probably (hopefully) avoid losing money since the stock price is relatively stable.
Related or Semi-related Video
Finance: What is a naked option/position...7 Views
Finance a la shmoop what is a naked option or naked option position? alright
warning you're going to be disappointed in this video it's not nearly as hot as [Censored man jumps into lake]
you probably hope naked options are just options that you sell or buy without
having enough of the underlying security to cover your if the price changes in
the wrong direction all right well they're an investment
that stands on their own but with extreme amounts of risk.....You invest [Man discussing investment in a lake]
$10,000 in coca-cola stock at 40 bucks a share buying 250 shares the stock goes
up $2 in a year or 5% not a bad score and you've made a whopping five percent on
your money or about five hundred bucks you bought the stock not the option and
remember when you own the stock you can own it forever there's no clock ticking [Clock ticking by]
in the background like there is with an option okay but let's say you had spent
that same 10 grand worth of naked coca-cola call options on options with a
strike price of 42.50 expiring in four months well the stock remains at 42.50
the whole time doesn't budge well guess what you've lost all of your money [Man with empty jean pockets]
had the stock under $45 however that 10 grand invested in those call options
which bought you exposure to some 20,000 shares would have made you something
like 250 a share that's of in-the-money value on those options times 20,000
shares or 50 grand yeah way more than your boring experience of just owning
the stock and making a whopping 500 bucks but you'll also risk losing
everything and this kind of foot's with whole notion of risk and reward being [Man in between reward and risk]
married in some unholy alliance where they kind of wrestle and yell at each
other all the time right so you took a lot of risk in buying
call options with nothing behind them you bought em naked
you could have made a fortune but you didn't because he played it safe and
bought the stock well in reality professional investors rarely just buy
naked options alone because they are so risky and so volatile but every now and [Ball spinning on roulette wheel]
then somebody bets the ranch on 22 black it comes up they make 36 times their
money in a week and everyone asked them for the best way to angle their thumb
when they're trying to flip a head on a quarter and we actually have a whole
video on that you should watch it it's kind of depressing...
Up Next
The intrinsic value of an option is the share price of a stock minus its strike price - i.e. the "in the money" amount.
What are stock options? Stock options are derivative contracts, each representing 100 shares, that give the holder the right to buy (call) or sell...
What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...