The term alligator spread is used to describe a combination of puts and calls that are not profitable due to relatively high commissions. Alligator spread refers to the investor’s position being “eaten alive” by the commissions.
An alligator spread is said to exist when an investor’s profits are eaten away by large commissions. This effect is not the result of market inefficiencies; rather it is a direct result of a broker’s commission schedule. The term is oftentimes used when describing the options market, and can occur even if the markets move in a direction favorable to the investor’s position.
While most alligator spreads seem to occur in an unsystematic fashion; it is possible that a broker intentionally arranges a combination of puts and calls that result in a loss-creating spread. For example, an investor’s potential profit on a put and call option paring might be $1,000, but the commissions on the necessary transactions might be $1,200. A thorough understanding of the broker’s commission schedule will help investors to avoid finding themselves in this situation.
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