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Alligator spreads are something of a rarity, although they are definitely a welcome phenomenon for an financial advisor who works on a commission basis. Essentially, an alligator spread is a mix of put options and call options that, when executed in the right order and time frame, will result in very hefty commissions for the agent. Here is some information about how the alligator spread got its name, as well as how this process can impact the underlier.
While no one would begrudge any financial professional from making a decent commission on any transaction, the fact is that the unique blend of put options and call options that help to set up an alligator spread can result in an extremely high commission. In fact, the commission can be so high that when all the dust settles, the investor realizes very little from the deal. Most of the profit ends up going to the advisor in the form of a commission. Thus, while an alligator spread is a nice windfall for any broker or other type of financial advisor, they do next to nothing for the net worth of the investor.
The name applied to this sort of financial transaction has a lot to do with the popular imagery of the alligator. Considered to be dangerous and capable of catching and swallowing any number of animals whole, the term of alligator spread points to the fact that this sort of transaction gobbles up all the potential for the investor to return a profit on his or her investment. In effect, the broker has engaged in the act of eating the investor alive, from a financial point of view.
While it is possible for a broker to create a premeditated alligator spread scheme, the phenomenon more often occurs due to a random series of call and put options. Both the investor and the broker can take steps to prevent this sort of spread from occurring by paying close attention to the sequence and the type of options that are engaged. One of the most important ways of preventing an alligator spread from emerging is to consider what impact a possible next step will have when paired with the last several actions taken. Also, spending a little time in determining what type of commissions may result from adding the next put or call to the mix may also help the investor to see if this is really a step that is worth the time and effort.