Vertical Spread- Part1

Spread is a strategy that involves buying one option either call or put and selling another, which results in both long and short option contracts. Vertical Spreads are made up of 

• all calls or all puts of same underlying stock
• of same expiry month but different strike price 
• with one long position and other short position
• of 1:1 ratio.

Vertical spreads can be debit spread or credit spread. When the premium received is less than premium paid, is called debit spread & vice versa in credit spread.

There are four types of Vertical Spread.

1. Bull Call Spread
2. Bear Call Spread
3. Bull Put Spread
4. Bear Put Spread

• Bull Call Spread:
• Buying one call option and selling another of higher strike price.
• It's a debit spread.
• Moderately Bullish Strategy.
• Maximum Profit : Difference between two strike price (-) Net debit.
• Maximum Loss: Net Premium paid
• Breakeven Point: Lower strike price (+) Net debit
• Profit: when closing of underlying stock is in-the-money.

Example:

Apple 470/475 Spread

Buy 1 lot Apple Feb 470 Call @ $10

Sell 1 lot Apple Feb 475 Call @ $ 6

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Net Debit: $4 (10-6)

Maximum Profit: $1 ie 100 (1*100)

Maximum loss: $4 ie 400 (4*100)

Breakeven Point: $474 (470+4)

• Bear Call Spread:
• Buying one call option and selling another of lower strike price.
• It's a credit spread.
• Moderately Bearish Strategy.
• Maximum Profit : Net Premium received
• Maximum Loss: Difference between two strike price (-) Net Credit
• Breakeven Point: Lower strike price (+) Net Credit
• Profit: when closing of underlying stock is Partially out-of-the--money.

Example:

Apple 475/470 Spread

Buy 1 lot Apple Feb 475 Call @ $ 6

Sell 1 lot Apple Feb 470 Call @ $ 10

-----------------------------------------------

Net Credit : $4 (10-6)

Maximum Profit: $4 ie 400 (1*100)

Maximum loss: $1 ie 100 (1*100)

Breakeven Point: $474 (470+4)

In the next blog we will see Bull Put Spread and Bear Put Spread.