A:

An alligator spread refers to a financial position (a unique combination of put and call options) that is unprofitable because of the high commission it generates. This phenomenon is called an alligator spread because the position is said to "eat alive" whatever profit the investor makes from the position. This spread is only seen with financial advisors or brokers that work on a commission basis. The unprofitability of the position is not necessarily caused by market effects but by the commission of the intermediary brokering the transaction.

The unique blend of put and call options that help to set up an alligator spread can result in commission that can be so high that most of any realized profits end up going to the broker and the investor realizes next to nothing from the deal. For example, if the executed position makes a profit of $2000, the commission might be between $1000 and $1500, thereby wiping out the profit and netting the investor next to nothing.

It is very possible for a broker to intentionally arrange a put and call option combination that results in an alligator spread, but for the most part, an alligator spread happens randomly. One way of dealing with an alligator spread is for the investor to look at the commission schedule for the broker or financial advisor and be aware of the commission levels for certain put and call positions. Another way of trying to prevent alligator spreads is for the investor and the broker to pay careful attention to the sequence of call and put options being paired and what the consequences or possible results of the pairing will be.

To learn more about commissions, and how they can affect quality of service, be sure to check out our related article Paying Your Investment Advisor - Fees Or Commissions?

This question was answered by Chizoba Morah.

RELATED FAQS
  1. How do I set a strike price in an options spread?

    Find out more about option spread strategies, and how to set the strike prices for bull call spreads and bull put spreads ... Read Answer >>
  2. What's the difference between a credit spread and a debt spread?

    Learn about debit and credit option spread strategies, how these strategies are used, and the differences between debit spreads ... Read Answer >>
  3. What are some examples of financial spread betting?

    Learn how financial spread betting is done, and see examples of some of the ways that investors can use spread betting as ... Read Answer >>
  4. What is spread hedging?

    Learn about one of the most common risk-management strategies options traders use, called spread hedging, to limit exposure ... Read Answer >>
  5. What is the average debt/equity ratio for the Internet sector?

    Learn about how debit option spreads work, including their maximum profit and loss, and understand how time decay impacts ... Read Answer >>
Related Articles
  1. Trading

    What's an Alligator Spread?

    An alligator spread is a financial position that generates too many commissions to be profitable.
  2. Trading

    Exploring The Williams Alligator Indicator

    Bill William’s Alligator Indicator provides a useful visual tool for trend recognition and deciding when to enter or exit a trade.
  3. Trading

    How To Pay Your Forex Broker

    Three types of commissions are used in this market. Learn how to get the best deal.
  4. Trading

    What is a Bull Call Spread?

    A bull call spread is an option strategy that involves the purchase of a call option, and the simultaneous sale of another option (on the same underlying asset) with the same expiration date ...
  5. Trading

    Vertical Bull and Bear Credit Spreads

    This trading strategy is an excellent limited-risk strategy that can be used with equity as well as commodity and futures options.
  6. Trading

    What Is A Bull Put Spread?

    Investopedia explains: A bull put spread is a variation of the popular put writing strategy, in which an options investor writes a put on a stock to collect premium income and perhaps buy the ...
  7. Trading

    Which Vertical Option Spread Should You Use?

    Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading.
  8. Personal Finance

    How Does Commission Work?

    A commission is the charge that brokers or investment advisors assess in exchange for their services.
  9. Trading

    Retail FX Spreads: Do They Even Matter?

    Learn how retail forex spreads affect your ability to trade currencies.
RELATED TERMS
  1. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions ...
  2. Buy A Spread

    Option strategy that will be profitable if the underlying security ...
  3. Long Leg

    The part of an option spread strategy that involves buying an ...
  4. Spread

    1. The difference between the bid and the ask price of a security ...
  5. Short Leg

    Any contract in an option spread in which an individual holds ...
  6. Bull Call Spread

    An options strategy that involves purchasing call options at ...
Hot Definitions
  1. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  2. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  3. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  4. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
  5. Border Adjustment Tax

    A tax levied on goods based on where they are sold – exported goods are exempt from tax; those imported and sold in the ...
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
Trading Center