Visually construct and analyze options strategies

 

Vertical Spread

Options Strategy - Vertical Spread

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.

Options Strategies :: Basic Spreads :: Vertical Spread Back to top