Vertical Spreads

Opinion: Depending on which option is purchased and which written, this could be a bullish or bearish 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.

Example:
Long 1 Oct 60 Call @ 5 1/8
Short 1 Oct 65 Call @ 3 1/8

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.

Selection: Month & Strike Price.

Bull Spread: The more bullish the investor’s outlook, the farther apart the strike prices. If less bullish, select strike prices that are closer together.

For bull spreads using Calls, the more the long Call is in-the-money, the more conservative the spread. For bull Put spreads, the more ITM the two striking prices, the more aggressive the spread.

The price of any bull spread is directly related to its being ITM or OTM and the amount of time until its expiration.

Bear Spread: The more bearish the investor’s outlook, the farther apart the strike prices. If less bearish, select strike prices that are closer together.

For bear Call spreads, the more the short Call is ITM, the more aggressive the spread. For bear Put spreads, the more OTM the two striking prices, the more aggressive the spread.

The price of a bear spread is directly related to its being ITM or OTM and the amount of time until its expiration.

Profit & Loss 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.