290 strike 280 strike (650-350)= $300 (290-280)x100-300= $700

280 strike 270 strike (350-170)= $180 (280-270)x100-180= $820

290 strike 270 strike (650-170)= $480 (290-270)x100-480= $1,520

*Not including commission and other fees.

Better Return for the Risk

Of the three general strategies: trading futures, buying options, or buying option spreads, the last has the least risk. For example, a typical futures contract can gain or lose between $500 to $1,000 in any one day on average. Option spreads, in contrast, typically move only $50 to $100 in any one day. For futures traders, especially those with trading accounts below $5,000, lowering risk is paramount. Option (debit) spreads require no margin and the downside risk is known and fixed beforehand: the most that can be lost in a worse case scenario is the price initially paid to establish the position, including commission and fees.

Even though an outright futures position will return the greatest profit per point movement of the underlying contract, the risk associated with futures makes them unattractive to traders with small-sized accounts. Options have limited risk and this makes them more appealing, but the cost of option premiums can significantly deteriorate performance over time. Option spreads have the advantageous risk characteristics of outright options, but the upfront cost is lower and this helps to put the odds in favor for the trader. Relative to outright options, an option spread generates a superior risk-adjusted return because the spread essentially sells the lottery portion of the option. This is graphically depicted below.

The return frontier of the long call option is the familiar hockey-stick pattern shown as the dashed line. The underlying futures price is at F so the call option is at-the-money. (It has a strike price of F.) A bull call spread is created by simultaneously selling another call option struck at G, and the return frontier is shown as the bent solid line. By employing the option spread, the trader receives the cash amount A, realized by the selling of the higher-strike option and, in return, sacrifices any further gain, shown as B, if prices should happen to rise beyond the higher strike price, G. The payout B is regarded as the lottery portion of the option as the underlying futures must rally considerably for it to be realized. This lottery portion has risk/return characteristics that are very similar to that of a deep out-of-the-money option: the buyer pays only a little, but must wait for a significantly large movement of the underlying futures price for any payout. Buying deep out-of-the-money options, while intuitively appealing to many investors, is a strategy that has a slim chance of earning net profits over time. This fact has become so well established within the industry that regulators require all option disclosure statements to specifically advise customers that there is only a remote likelihood of profit from buying deep out-of-the-money options. In the same way, the lottery portion of the option is a net loser over time. Hence, the trader can improve their overall performance over a strategy of buying options by buying option spreads instead as this effectively sells the lottery portion of the option.