What Is A Vertical Spread?: Definition
A vertical options spread is a combination of bought or sold options of the same underlying security and expiry date (but different strike prices).
This combination could be of either puts or calls and may result in either a credit (credit spreads) or debit (debit spreads).
Vertical Spread Examples
The following are examples of vertical spreads:
Bull Call Spread
A debit spread put on when a trader believes a stock will rise.
It involves the purchase of a call option, partly financed by the sale of a call (over the same underlying and with the same expiry) with a higher strike price.
As the higher expiry call will have a lower premium, this will result in a net debit.
The above P&L Diagram shows the maximum profit is the difference between the two call’s strike prices, less than the net premium paid. The maximum loss is this premium.
The long call strike price plus the net premium paid is the strategy’s breakeven point.
There’s more info on the bull call spread here.
Bear Call Spread
A credit spread for when an investor expects a stock to fall.
The spread involves a sold call option and purchased call at a higher strike price to reduce the risk should the stock actually rise. As the higher expiry call will have a lower premium, this will result in a net credit.
The maximum profit is the net premium received, as we can see from the above P&L Diagram. The maximum loss is this the difference between the two calls’ strike prices, less the net premium.
The breakeven point is the short call’s strike price plus the net premium.
Bull Put Spread
A credit spread put on when a trader believes a stock will rise.
It involves the sale of a put option, and a purchase of a put with a lower strike price. As the lower expiry put will have a lower premium, this will result in a net credit.
The maximum profit is the net premium received, as we can see from the above P&L Diagram. The maximum loss is this the difference between the two puts’ strike prices, less the net premium.
The breakeven point is the long put strike price plus the net premium paid.
Bear Put Spread
A debit spread for when an investor expects a stock to fall.
The spread involves a purchased put option partly financed by the sale of a put at a lower strike price. As the lower expiry put will have a lower premium, this will result in a net debit.
As we can see from the above P&L Diagram, the maximum profit is the difference between the two calls’ strike prices, less the net premium. The maximum loss is the net premium.
The breakeven point is the long put’s strike price less the net premium.
There’s more info on the bear put spread here.
