Vertical Spread

What Is a Vertical Spread?

A vertical spread includes the simultaneous buying and selling of options of a similar type (i.e., either puts or calls) and expiry, yet at various strike prices. The term 'vertical' comes from the position of the strike prices.

This is as opposed to a horizontal, or calendar spread, which is the simultaneous purchase and sale of a similar option type with a similar strike price, however with various expiration dates.

Figuring out Vertical Spreads

Traders will utilize a vertical spread when they expect a moderate move in the price of the underlying asset. Vertical spreads are predominantly directional plays and can be tailored to mirror the trader's view, bearish or bullish, on the underlying asset.

Contingent upon the type of vertical spread sent, the trader's account can either be credited or debited. Since a vertical spread includes both a purchase and a sale, the proceeds from [writing](/composing an-option) an option will to some degree, or even completely, offset the premium required to purchase the other leg of this strategy, in particular buying the option. The outcome is many times a lower cost, lower risk trade than a naked options position.

Be that as it may, in return for lower risk, a vertical spread strategy will cover the profit potential too. On the off chance that an investor expects a substantial, [trend-like](/moving business sector) move in the price of the underlying asset then a vertical spread is definitely not a proper strategy.

Types of Vertical Spreads

There are several assortments of vertical spreads.

Bulls

Bullish traders will utilize bull call spreads and bull put spreads. For the two strategies, the trader purchases the option with the lower strike price and sells the options with the higher strike price. Beside the difference in the option types, the principal variation is in the planning of the cash flows. The bull call spread brings about a net debit, while the bull put spread brings about a net credit at the beginning.

Bears

Bearish traders use bear call spreads or bear put spreads. For these strategies, the trader sells the option with the lower strike price and purchases the option with the higher strike price. Here, the bear put spread brings about a net debit, while the bear call spread brings about a net credit to the trader's account.

Computing Vertical Spread Profit and Loss

All models do exclude commissions.

Bull call spread: (premiums bring about a net debit)

• Max profit = the spread between the strike prices - net premium paid.
• Max loss = net premium paid.
• Breakeven point = long call's strike price + net premium paid.

Bear call spread: (premiums bring about a net credit)

• Max profit = net premium received.
• Max loss = the spread between the strike prices - net premium received.
• Breakeven point = short call's strike price + net premium received.

Bull put spread: (premiums bring about a net credit)

• Max profit = net premium received.
• Max loss = the spread between the strike prices - net premium received.
• Breakeven point = short put's strike price - net premium received.

Bear put spread: (premiums bring about a net debit)

• Max profit = the spread between the strike prices - net premium paid.
• Max loss = net premium paid.
• Breakeven point = long put's strike price - net premium paid.

Genuine Example of a Bull Vertical Spread

An investor hoping to wager on a stock moving higher may set out on a bull vertical call spread. The investor purchases an option on Company ABC, whose stock is trading at $50 per share. The investor purchases a in the money (ITM) option with a strike price of $45 for $4 and sells a out of the money (OTM) call with a strike price of $55 for $3.

At expiration, Company ABC's stock trades at $49. In this case, the investor would exercise their call, paying $45 and afterward selling for $49, netting a $4 profit. The call they sold lapses worthless.

The $4 profit from the stock sale, plus the $3 premium and less the $4 premium paid, leaves a net profit of $3 for the spread.

Features

• Vertical spreads limit both risk and the potential for return.
• Bull vertical spreads increase in value when the underlying asset ascends, while bear vertical spreads profit from a decline in price.
• A vertical spread is an options strategy that includes buying (selling) a call (put) and simultaneously selling (buying) another call (put) at an alternate strike price, however with a similar expiration.