Wednesday, February 8, 2012

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

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.





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