Wednesday, January 30, 2013

Introduction to Vertical Spreads

A vertical spread option strategy that contains a call option and a put option, both expiring in the same month. This strategy can be implemented with calls or puts, and is known as a directional investment strategy. If you run a vertical spread a call option, it means you were bullish on the underlying asset (bull call spread), and if you ran a spread vertically in a put option, you'd still bearish regarding the underlying asset (bear put spread )

For the investor is much more flexible run a vertical spread vanilla transaction.

Let's look at a typical strategy.

ABC shares are trading around $ 60.05, and you think his price will go up. A call option in June of $ 57 will cost $ 5.50. Among the investment options in foreign exchange purchases and pay for the call option premium of $ 5.50, which is the totality of your risk. You can reduce that risk by selling a call option near the price you think ABC shares reach. So you sell a call option for $ 68 and receive a premium of $ 1.05. Now you've reduced your risk of $ 5.50 to $ 4.45.


You have to pay a price to reduce your risk, and that, indeed, you put your cap on benefits. The most you can win with your Vertical spread is the difference between the strike prices of $ 57 and $ 68, a maximum of $ 11. If they expire, ABC's shares are quoted at $ 68, your final benefit would be $ 6.55 ($ 11 minus $ 4.45 risk). To make money with this operation, and paid a net premium of $ 4.45, shares of ABC must contribute at least $ 61.45, a fluctuation of only $ 1.40 on its current price of $ 60.05.

Now study one vertical spread is already "in the money". Even call option bought our shares of ABC for $ 57 with a premium of $ 5.50, but this time sell a call option of $ 58.70 with a premium of $ 4.40. The cost of this vertical spread $ 1.10 ($ 5.50 - $ 4.40). The difference between $ 57 and $ 58.70 is $ 1.70, so we have a potential profit of $ 0.60 ($ 1.70 - $ 1.10). Not much benefit, but ABC shares trading around $ 60.05 above the short option ($ 1.35), the stock price of ABC must not fluctuate at all for the position is profitable.

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