Introduction to Spreads and Bullish Call Spreads

[theelderwand]

Options spreads in layman terms are two options of the same type (call or put) on the same underlying, one bought and another one being sold. They differ in terms of the strike prices or the expiration or both.

Let’s look at the different types of option spreads.

Vertical Spreads

These are options spreads where the options are on the same expiry and the strike prices are different. Vertical spreads are the easiest of spreads to understand and we will be delving slightly deeper into verticals in the upcoming section

Horizontal Spreads

These are advanced spreads where the options are on the same strike while being on different expirations. They are played to exploit IV premium during binary events like earnings.

Diagonal Spreads

These are an added variant on Horizontal spreads where the strike prices differ as well along with the expiration date. One key thing to note is the options are always of the same type in spreads.

Buying Vertical Spreads

Vertical spreads or the easiest of spreads to understand and possible the most common options strategies. They get their name from how they look on the option chain (see below)

There are a couple of reasons why one would choose vertical spreads

• Getting a long option at a discounted price
• When IV is high, option prices are elevated, verticals help offset the IV to make a directional bet.

Vertical spreads allow options traders to make directional bets at a discounted cost. In case of vertical spreads the maximum profit is defined (not infinite) and the maximum loss is the premium paid for buying the spread. As you might have already guessed, there are two types of vertical spreads and they correspond to the two directional bets that traders can place.

1. Bullish Call Spread (a.k.a) Debit Call Spread
2. Bearish Put Spread (a.k.a) Debit Put Spread

Bullish Call Spread

The bullish call spread allows traders to make a bullish bet by defining their maximum profit and getting long a call option discounted by a shorter call option at a higher strike.

Consider the following trade being placed from ThinkOrSwim

This is an example of a bullish call spread with the following components,

• Long 3000 Call - Buying the right to buy SPX at 3000
• Short 3010 Call - Selling the obligation to sell SPX at 3010
• Net Debit of 430$ (excluding commissions)

The break even on this trade is 3000 + 4.30 = 3004.30.

The following are the cases at expiration,

• SPX closes below 3004.30: We realize a loss up to a maximum of 430$
• SPX closes above 3004.30: We realize profits up to a maximum of 1000$ - 430$ = 570$
• SPX closes above 3004.30: Break even

The next confirmation screen should help understand this better.

The Analyze tab, would give us a better idea on how this works out.

Next up: How to Buy your first call spreads.

 

[Daybuck]

I prefer to trade 0DTE credit spreads on SPX Index. Anyone have any suggestions as to what indicator would suit my needs to find the best entries and exits? Much thanks!

 

[jan_angel]

Does any one here use 0 DTE iron fly strategy for SPX? If so, are there any indicators you use to help guide your exit points?

 

[theelderwand]

@Daybuck @jan_angel I rarely do same day. Best tools that I can suggest are the following

• VWAP for resistance and support
• Good old charting
• ORB not sure if this helps, @BenTen can guide you better.

Also, SPX is cash settled, consider SPY as it's physically settled, worst case you get stock which you can rotate for the next expiry (i.e.) if you are assigned long, sell calls and if you are assigned short sell puts against it.

 

[Kapitalk12]

I understand you buy the call option close to stock price for Call Debit Spread. But how do you know which strike to choose further out? That's what I'm really confused on. Example, If stock is at 50, I buy the 50 call and sell the 52 Call. My spread is $2. But that doesn't really make you any profit barely. Does this make sense? If I made the spread $10 wide, from what I'm read, its dangerous to have a large spread on it. If bought the spread 3 weeks out and only planned on holding it for a few days or a week max, would it be okay to make my debit spread $10 wide?? Can someone please help, I'd really appreciate getting my confusion cleared up. Thank you!