CandleFocus Glossary Editor
A vertical spread is a type of options strategy used to take advantage of the changes in the price of the underlying asset. An options trader may establish a vertical spread by either:
buying one call option and selling another call option of the same class at a different strike price, or
buying one put option and selling another put of the same class at a different strike price with the same expiration date.
A vertical spread strategy allows traders to enter a trade with a defined maximum potential loss and maximum potential profit. As with all options strategies, the potential risk and reward is also known in advance. No matter what the underlying stock price does in the future, the vertical spread price is fixed.
The main difference between a vertical spread and buying a single option is that a vertical spread includes both the vertical spread’s short and long options. By creating a spread, a trader reduces the cost of buying (or selling) the higher (lower) strike options, making the trade more cost-effective.
Two of the most well-known and widely used types of vertical spread strategy are bull and bear.
A bull vertical spread utilizes both call options. The investor buys the call with the lower strike at a lower premium and sells the call with the higher strike at a higher premium. The spread benefits from the underlying stock price appreciating and will make money if the stock’s price moves above the higher strike price.
In the case of a bear spread, the investor sells the lower strike call and buys the higher strike call. The spread’s profit potential is limited since the underlying stock’s price has to drop below the lower strike price.
Vertical spread strategies can be established with long or short positions. Regardless of the market environment, vertical spreads are widely used as a powerful risk management tool and produce excellent risk/reward ratios. In addition, since the trader knows the maximum gain and maximum loss in advance, they can easily calculate their risk/reward ratio before entering into a vertical spread position.
The effects of changing the strikes to increase or decrease the maximum loss or gain are easy to understand and control. Overall, vertical spreads are useful options strategies for traders who are looking for directional exposure, with the advantage of known risks and rewards.
buying one call option and selling another call option of the same class at a different strike price, or
buying one put option and selling another put of the same class at a different strike price with the same expiration date.
A vertical spread strategy allows traders to enter a trade with a defined maximum potential loss and maximum potential profit. As with all options strategies, the potential risk and reward is also known in advance. No matter what the underlying stock price does in the future, the vertical spread price is fixed.
The main difference between a vertical spread and buying a single option is that a vertical spread includes both the vertical spread’s short and long options. By creating a spread, a trader reduces the cost of buying (or selling) the higher (lower) strike options, making the trade more cost-effective.
Two of the most well-known and widely used types of vertical spread strategy are bull and bear.
A bull vertical spread utilizes both call options. The investor buys the call with the lower strike at a lower premium and sells the call with the higher strike at a higher premium. The spread benefits from the underlying stock price appreciating and will make money if the stock’s price moves above the higher strike price.
In the case of a bear spread, the investor sells the lower strike call and buys the higher strike call. The spread’s profit potential is limited since the underlying stock’s price has to drop below the lower strike price.
Vertical spread strategies can be established with long or short positions. Regardless of the market environment, vertical spreads are widely used as a powerful risk management tool and produce excellent risk/reward ratios. In addition, since the trader knows the maximum gain and maximum loss in advance, they can easily calculate their risk/reward ratio before entering into a vertical spread position.
The effects of changing the strikes to increase or decrease the maximum loss or gain are easy to understand and control. Overall, vertical spreads are useful options strategies for traders who are looking for directional exposure, with the advantage of known risks and rewards.