Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Options spreads are trading strategies that involve two or more options designed to manage risk while providing opportunities for profit. Traders using an option spread simultaneously buy multiple options on the same underlying asset with different strike prices, different expiration dates, or both.
Understanding options spreads can help you decide whether these strategies could work for your portfolio, and which one to use in a given situation.
Key Points
• Options spreads are strategies using multiple options to manage risk and enhance profit potential.
• Vertical spreads involve options with the same expiration but different strike prices.
• Horizontal spreads use the same strike prices but different expiration dates, capitalizing on time decay.
• Diagonal spreads combine different strike prices and expiration dates, offering versatile market positioning.
• These strategies can be implemented with calls or puts, tailored to bullish or bearish market outlooks.
Credit and Debit Spreads
The difference between credit and debit spreads in options investing is that, in a credit spread, a trader sells one option (receiving a premium) and buys another (paying a lower premium), with the net result being a credit to their account. Conversely, when they buy an option and sell an option with a lower premium, they pay a net premium to open the position, resulting in a debit to their account.
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3 Common Option Spread Strategies
Spread strategies occur when a trader buys and sells multiple call or put options pegged to the same underlying asset or security, but with different strike prices or expiration dates.
There are several types of option spreads. Here’s a look at a few common ones:
1. Vertical Spread Options
A vertical spread is an options strategy in which the options have the same expiration date but different strike prices. There are four types of vertical spread options that investors use depending on whether they are bullish or bearish, and whether the spread is a debit or credit.
Bull Call Spreads
A bull call spread strategy involves buying a call option at a lower strike price and selling another call option at a higher strike price. The call spread options have the same underlying asset and expiration date.
Traders may use this strategy when they expect the price of the underlying asset to increase, but want to limit potential loss by capping both their gains and losses.The trader caps their potential losses to the net premium they paid for the options. Their maximum gain is capped at the differences in strike prices, minus the net premium paid.
For example, a trader buys a call option on a stock at a strike price of $10, for a premium of $2. They then sell a call option with the same expiration date but at a strike price of $12, receiving a premium of $1. Conversely, if the stock price falls below $10 by expiration, the option would expire worthless and the trader’s loss is limited to the $1 premium.
This strategy limits the trader’s maximum loss to the net premium paid for the options. If the stock price rises above the higher strike price, the potential gain is capped at the difference between the strike prices, minus net premium paid. Although this cap limits the upside, it also provides protection against potential losses beyond the premium paid.
Bear Call Spreads
The opposite of a bull call spread, a bear call spread benefits from an underlying asset’s decrease in value.
For example, if a trader using a bear call spread anticipates a stock’s value is going to decrease, they would set up a spread by selling a call option and buying another call option at a higher strike price — the inverse of the bull call spread method. This is a credit spread, meaning the trader maximum gain is limited by the net premium received for the position. Their potential loss is capped at the difference in strike price. For example, a trader sells a call option on a stock at a strike price of $10, and buys another call at a strike price of $12.
Bull Put Spreads
A bull put spread is similar to a bull call spread, but it involves puts rather than calls. Using a bull put spread, a trader anticipates an increase in the underlying asset’s value. In our example, the trader would sell a put option at a strike price of $10, and simultaneously buy another at a lower strike price, which in this example is $8.
If the stock price remains above $10, both options expire worthless. The trader retains the full premium received as their maximum gain. If the stock price falls below $8, the trader incurs the maximum loss. This is capped at the difference between the strike prices minus the premium received.
Bear Put Spreads
A bear put spread is the inverse of a bull put spread. In our example, the trader would buy one put option at a $10 strike price, and simultaneously sell another put at a lower strike price, like $8.
The trader cannot lose more than the net premium the trader paid to take the position (as this is a debit spread) or gain more than the difference in strike prices.
2. Horizontal Spreads
Horizontal spreads (also called “calendar spread options”) involve options with the same underlying asset and same strike prices, but with different expiration dates. The main goal of this strategy is to generate income from the effects of time decay or the volatility of the two options.
There are also two main types of horizontal spreads.
Call Horizontal Spreads
A call horizontal spread is a strategy which a trader would employ if they believed that the underlying asset’s price would hold steady. In this case, the trader would buy a call with an expiration date on January 15th, for example, and sell another call with a different expiration date, like January 30th.
The trader can also reverse these positions by selling a call option that expires on January 15th, and another that expires on January 30th. The two positions’ differing expiration dates act as buffers, limiting potential losses (the premium paid) and gains.
Put Horizontal Spreads
Put horizontal spreads similar to call horizontal spreads except that traders use puts instead of calls.
3. Diagonal Spreads
Diagonal spreads incorporate elements from both vertical and horizontal spread strategies. These spreads involve the same option types and underlying asset (the same as before), but with differing strike prices and differing expiration dates.
Diagonal spreads — with different strike prices and expiration dates — allow for a variety of options combinations, and can be used under different market conditions. For example, they can be bearish and bullish, use calls or puts, and use different time horizons (long or short).
Other Options Spreads
While we’ve covered the main types of options spread strategies, there are a few more you may run into.
Butterfly Spread Options
A butterfly spread incorporates multiple strike prices, and can utilize either calls or puts. It also combines a bull and bear spread across four different options.
An example would be a trader buying a call at a certain strike price, selling two more calls at a higher strike price, and then buying another call at yet an even higher strike price—of equal distance, or value, from the two central calls. This results in a cap on losses and gains, and the trader could realize gains depending on the volatility levels of the underlying asset.
Box Spread Options
A box spread option strategy involves a bear put and a bull call with identical strike prices and expiration dates. Under very specific circumstances, traders employ box spreads when they are looking to capitalize on arbitrage opportunities.
The Takeaway
There are several spread strategies for options trading that traders use to limit their losses and position themselves for potential gains based on their projections about the price of a specific asset.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
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