Tuesday, February 17, 2015

Options Spread

In option trading, there are many option strategies you can use. There are two basic options: call option and put option. Call contract will give the holder the right to buy an asset at a specific price or strike price. Put contract is the opposite. It gives the right to sell an asset at strike price.

You can combine those two basic options and create lots of strategies. Each option has its own strike price and expiration date. You can buy and sell option with different strike price and expiration date to create many strategies. Those strategies can be categorized into options spread. There are 3 types of options spread. They are vertical spread, horizontal spread, and diagonal spread. Spreads are created by selling and buying options on the same asset.

Vertical spread is a strategy which is created by purchasing and selling two options on the same asset and expiration date but different strike price. An example of this spread is bear call spread, bull call spread, bear put spread, and bull put spread. These strategies can be used in moderate bullish and bearish conditions. Vertical spread has limited reward and minimum risk.
Horizontal spread is a strategy which is created by purchasing and selling two options on the same stock and strike price but different expiration dates. Horizontal spread is also known calendar spread. Calendar spread is a neutral strategy. You will get profit when the asset remains stagnant or only moves within tight range. Calendar spreads makes profit from the difference in premium decay. Shorter options premiums will decay faster than longer options. Calendar spread buys longer options and sells shorter options. A longer option is more expensive then shorter options.
Diagonal spread is a strategy which is created by purchasing and selling two options on the same stock but different strike price and expiration date. This strategy is used when you think that the stock is bullish or bearish in long term but neutral in short term.
Because you are selling and buying options in the same time, it is possible that you aren't spending any money when you enter the position. It is called credit spread. Credit spread is an option strategy which the premium you received from selling option is higher than the premium you pay when buying the option. This means you are actually making instant money when using this strategy. The money you receive is called Net Credit and this will be the maximum profit you can get.

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