Trading Strategies (Options) – 3
In my previous two posts about Trading Strategies, I discussed about COVERED POSITIONS. Today I am going to discuss about OPTIONS SPREADS.
What is an Option Spread?
It involves the simultaneous purchase and sale of options in the same class, ie, calls or puts on the same underlying.
There are different types of options spreads, Those are as below..
1. Vertical spread
Buying and selling calls/puts with different strikes, but the same expiry.
eg. buy Nov 1200 call and sell Nov 1300 call or
buy Dec 1000 put and sell Dec 1100 put
2. Horizontal (calendar) spread
Buying and selling options with same strike, but different expiry months.
eg. buy Nov 1200 call and sell Dec 1200 call or
buy Oct 1000 put and sell Nov 1000 put
3. Diagonal (diagonal calender) spread
Buying and selling options with different strikes and different expiry months.
In this post I am going to discuss the Vertical spread in detail.
These vertical spreads can be classified into two basic types: bull spreads and bear spreads
In a bull spread the investor buys the lower strike and sells the higher strike. Where as in a bear spread the investor sells the lower strike and buys the higher strike.
Basically the vertical spreads are used to profit from a directional movement in the underlying. However One must use these strategies when they are moderately bullish/bearish on the underlying.
Bull spreads can again be classified into Bull Call spread and Bull Put spread
Bull Call A strategy to be used when an investor is moderately bullish on the underlying, and it is constructed by buying a CALL option with lower strike, and selling a CALL option with higher strike.
Bull Put This is also a strategy to be used when an investor is moderately bullish on the underlying, and is constructed by buying a PUT option lower strike, and selling a PUT option with higher strike.
Below is the summary of the bull spreads..
| Bull Call | Bear Call | Bull Put | Bear Put | |
|---|---|---|---|---|
| Motivation | Moderately Bullish | Moderately Bearish | Moderately Bullish | Moderately Bearish |
| Construction | Buy lower strike, sell higher strike. | Sell lower strike, buy higher strike. | Buy lower strike, sell higher strike. | Sell lower strike, buy higher strike. |
| Net permeum | Paid out. | Received. | Received. | Paid out. |
| Maximum risk | Net premium paid. | Difference in strikes less net premium received. | Difference in strikes less net premium received. | Net premium paid. |
| Maximum reward | Difference in strikes less net premium paid. | Net premium received. | Net premium received. | Difference in strikes less net premium paid. |
| Breakeven point | Lower strike + net premium paid. | Lower strike + net premium received. | Higher strike – net premium received. | Higher strike – net premium paid. |
That’s it for now about Vertical spreads; I shall discuss Horizontal & Diagonal spreads in my next post.
Happy Trading! 
