In options trading, an option spread is created by the simultaneous purchase and sale of options of the same class on the same underlying security but with different strike prices and/or expiration dates.
Option buyers can consider using spreads to reduce the net cost of entering a trade. Naked option sellers can use spreads instead to lower margin requirements so as to free up buying power while simultaneously putting a cap on the maximum loss potential.
The three basic classes of spreads are the vertical spread, the horizontal spread and the diagonal spread. They are categorized by the relationships between the strike price and expiration dates of the options involved.
Vertical spreads are constructed using options of the same class, same underlying security, same expiration month, but at different strike prices.
Horizontal or calendar spreads are constructed using options of the same underlying security, same strike prices but with different expiration dates.
Diagonal spreads are created using options of the same underlying security but different strike prices and expiration dates.
If an option spread is designed to profit from a rise in the price of the underlying security, it is a bull spread. Conversely, a bear spread is a spread where favorable outcome is attained when the price of the underlying security goes down.
Option spreads can be entered on a net credit or a net debit. If the premiums of the options sold is higher than the premiums of the options purchased, then a net credit is received when entering the spread. If the opposite is true, then a debit is taken. Spreads that are entered on a debit are known as debit spreads while those entered on a credit are known as credit spreads.
Altogether, there are quite a number of options trading strategies available to the investor and many of them come with exotic names. Here in this website, we have tutorials covering all known strategies and we have classified them under bullish strategies, bearish strategies and neutral (non-directional) strategies.
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