Spreads, Verticals, Vertical Spreads
What is a Vertical Spread?
A Vertical Spread is a way to invest in the price at or around which you think a stock, ETF, future, etc will be at expiration. Say for example GS (Goldman Sachs) is trading at 250 and you think the price is going to move before the next expiration of options which takes place on the 15th of December. You have a couple of ways to use spreads to take advantage of this movement since as the price moves, so will the value of your vertical spread.
Spreads will have the same expiration and be comprised of two separate options. Either both calls or both puts. Choosing a direction for the underlying will help to determine which side you want to be on, call side or put side that is. It will also help to determine whether to buy or sell, this too will depend on which direction you think the underlying will move.
How do I use this strategy?
There are a couple of different ways to make use of these types of strategies. Outlined below you will see two ways to utilize the spreads approach in trading.
Taking advantage of the Bullish approach: Theoretical outlook for GS is that the price will be rising through your expiration window.
Suppose you are looking at a chart and you think the stock price is going to rise during the expiration window. You could sell a put credit spread to make use of this approach with a bullish outlook.
Selling a Put Spread: Selling higher and buying lower for protection.
Ways to take advantage of the Bearish approach: Theoretical outlook is that the price will be falling during your expiration window.
Suppose you are looking at a chart and you think the stock price is going to fall during the expiration window. You could buy a call debit spread and or sell puts and achieve a similar approach with a bearish outlook.
Buying a Call Debit Spread: Buying lower and selling higher for protection.
Pro's and Con's
Vertical spreads are a great way to capitalize on directional movement while still managing and limiting your risk exposure to the market.
Limited potential to the upside based on position sizing.