Description
A Vertical Spread
(A.K.A. - Bull Spread
or Bear Spread depending
on the options selected)
involves buying
a Call option (or
a Put) and simultaneously
writing another
Call option (Put)
with the same expiration
but a different
strike price.
Bull or Bear?
Depending on
which option is
purchased and which
written, a vertical
spread can be either
a bullish or a bearish
spread.
Bullish Spreads:
- Long Call strike < Short Call strike
- Long Put strike < Short Put strike
Bearish Spreads:
- Long Call strike > Short Call strike
- Long Put strike > Short Put strike
When to use:
Bull Spread:
Used by an investor
who may not be entirely
comfortable with
either a long Call
or short Put position.
It is a popular
bullish trade because
it allows the investor
to establish a position
even when unsure
of his or her bullish
expectations.
Bear Spread:
Used by an investor
who thinks XYZ will
fall in price but
is not sure of magnitude.
A popular bearish
trade because it
may be entered as
a conservative position
when uncertain about
the likelihood of
a decline.
Risk/Reward
Characteristics
The second option
in a vertical spread
is generally added
because the investor
wants to either
reduce the cost
of a purchased option
or cap the loss
potential of a written
option. The investor
is in effect "hedging"
his or her opinion.
Break-even
Point: Vertical
Spread (Call):
Lower Strike Price
+ Spread Price;
Vertical Spread
(Put): Higher
Strike Price - Spread
Price
Time Decay:
Varies. If XYZ is
between strike prices,
time decay is minimal.
If XYZ is near the
long option's strike
price (60), losses
increase at faster
rate as time passes.
If XYZ is near written
option's strike
price (65), profits
increase at faster
rate as time passes.
Volatility:
The impact of a
change in volatility
on Vertical Spreads
depends on whether
one or both of the
options are in-the-money
and the amount of
time until expiration.
Assignment
Risk: As is
the case with all
written options,
the investor must
continuously monitor
the spread for possible
assignment pf in-the-money
options prior to
their expiration.
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