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Option Spreads


Spread

A spread is the implementation of an option strategy that involves the simultaneous purchase and sale of related options. This is often done to lower the cost to establish the position and minimize risk in the position. The options will be of the same type but with different strike prices and/or expiration dates.


Vertical Spread (Perpendicular Spread or Price Spread)

A Vertical Spread is produced by the simultaneous purchase and sale of options with different strike prices that have the same expiration date.


Horizontal Spread (Time Spread)

A Horizontal Spread is produced by the simultaneous purchase and sale of options with the same strike price but different expiration dates.


Bull Spread

A Bull Spread is established with two options, generally having the same expiration date but different strike prices. The lower strike price option is bought and the higher strike price option is sold. If calls are used to establish the position, it is called a Bull Call Spread. If puts are used to establish the position, it is called a Bull Put Spread. This type of position is established when you are bullish on the stock and it makes profits when the stock price rises significantly, but if you are wrong and the stock goes down significantly, your money is at risk.


Bear Spread

A Bear Spread is established with two options, generally having the same expiration date but different strike prices. The higher strike price option is bought and the lower strike price option is sold. If calls are used to establish the position, it is called a Bear Call Spread. If puts are used to establish the position, it is called a Bear Put Spread. This type of position is established when you are bearish on the stock and it makes profits when the stock price falls significantly, but if you are wrong and the stock goes up significantly, your money is at risk.


Box Spread

A Box Spread uses a bull spread and a bear spread to establish a near-riskless position. One spread uses call options and the other uses put options. One implementation can be two debit spreads (a call bull spread and put bear spread). Another implementation can be two credit spreads (a call bear spread and a put bull spread).


Butterfly Spread

A Butterfly Spread is implemented by the combination of a bull spread and a bear spread. This combination involves three strike prices, with the two higher strike prices implementing one spread and the two lower strike prices implementing the other spread, and the middle strike price shared by both spreads. There are four different ways of combinging puts and calls to construct a position with essentially the same characteristics. This option strategy has limited risk, but also limited profit potential.


Calendar Spread

A Calendar Spread is implemented by buying a long term option and selling a short term option, where they each have the same strike price. It can be implemented with calls or puts.


Ratio Spread

A Ratio Spread is implemented by buying a quantity of options and selling a larger quantity of options that are more out-of-the-money. This option strategy can be implemented with puts or calls.


Ratio Calendar Spread

A Ratio Calendar Spread is produced by the purchase of long-term options and the sale of a larger number of near-term options, all with the same strike price.


Delta Spread

A Delta Spread is a ratio spread where the ratio is set to make a neutral position. The delta of the options to be purchased is divided by the delta of the options to be sold, to determine the ratio for making a neutral position (the position delta will then be zero).


Diagonal Spread

Diagonal Spreads are implemented with options having different strike prices, where longer term options are purchased and short term options are sold. Diagonal spreads can be implemented as bullish or bearish strategies.





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