Spread trading options

Options spread definition What is an options spread? An options spread is an options trading strategy in which a trader will buy and sell multiple options of the same type — either call or put — with the same underlying asset. These options are similar, but typically vary in terms of strike price, expiry date, or both.

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Discover how to trade options Learn more about options trading and how to get started. What are the types spread trading options options spread strategies? There are three main types of options spread strategy: vertical, horizontal and diagonal.

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A vertical spread strategy — sometimes known as a money spread — uses two options with identical expiry dates but different strike prices. A vertical spread strategy enables traders to limit their downside risk, but in doing so, they also cap their upside potential. This is explained in the example below.

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Spread trading options horizontal spread strategy — also called a calendar spread — uses long and short options with identical strike prices but different expiry dates. The primary aim of a calendar spread is to profit from the effects of time decay on two different expiry options. This is because options that are nearing their expiry date are more susceptible to time decay than longer-term options. As a result, in spread trading options horizontal spread strategy a trader can use a long-term option to offset any losses incurred if a short-term option is looking likely to expire worthless, and potentially still profit from the longer-term option.

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A diagonal spread strategy involves simultaneously entering into long and short positions with two options of the same type, but with different strike prices and expiries. In this scenario, a trader would first buy a call option with a given strike, but also sell another call with a higher strike.

On the options chain, these positions appear vertically stacked, hence the name vertical spread.

Both options would share the same expiry. The time to expiry for both options is 45 days, and the spread on this strategy is the difference between the two strikes — 15 minus In a profit scenario, the market moves to or above at expiry.

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You sell the bought call at a profit that always exceeds, but is limited by, your loss on the sold call. Your maximum profit is calculated by subtracting the aggregate premium 6. In a loss scenario, the market moves below at expiry.

Any spread that is constructed using calls can be refered to as a call spread. Similarly, put spreads are spreads created using put options. Option buyers can consider using spreads to reduce the net cost of entering a trade. Naked option sellers can use spreads instead to lower margin requirements so as to free up buying power while simultaneously putting a cap on the maximum loss potential. They are categorized by the relationships between the strike price and expiration dates of the options involved.

Your maximum loss is simply the premium you paid 9. It is worth noting, that the sum of the maximum loss and profit for the strategy is equal to the spread 6.

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