An option spread involves simultaneously buying and selling options of the same type with different strike prices and expiration dates for the same underlying security.
Option spreads are appealing to investors because they can be used to reduce the total cost of entering a trade. This article will provide a basic understanding of certain option spreads so that investors can use these spreads in their own portfolio.
An option spread that uses call options is referred to as a call spread. An option spread that uses put options is referred to as a put spread.
There are three basic types of option spreads: the vertical spread, horizontal spread, and diagonal spread.
Vertical spreads are made up of options that are the same type for the same underlying security with the same expiration date but have different strike prices.
Horizontal spreads, also known as calendar spreads, are constructed using options that are the same type for the same underlying security with the same strike price but have different expiration dates.
Diagonal spreads are created using options that are the same type for the same underlying security but have different strike prices and expiration dates.
Other types of option spreads are bull spread and bear spreads. A bull spread is designed to profit from a rise in the price of the underlying security. A bear spread is designed to profit when the price of the underlying security goes down.
Option spreads can be entered on a net credit or debit. If the premiums of the options sold is higher than the premiums of the options bought, then the investor enters the spread with a net credit. This is known as a credit spread. If the premiums of the options sold is less than the premiums of the options bought, then the investor enters the spread with a net debit. This is known as a debit spread.
By reading this article, investors should have gained a basic introduction into the different types of option spreads. If investors are interested in entering trades with little or no cost, then option spreads are a good tool to use. Just be sure to do further research about certain option spreads before executing them.
