Stock options vertical spread
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Enriching lives worldwide through exceptional financial education. I love options for the tremendous variety of strategies they offer.
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One of the more creative ones is the Double Vertical spread. This strategy is appropriate when you have a strong bullish or bearish opinion on a stock or ETF; you want a limited-risk trade; and you want a trade that will not be affected too much by changes in volatility.
There are other strategies that could be used in this same situation, such as a directional butterfly. But I like the double vertical when I believe that there is a lot of potential for movement in my direction.
Here is an example:. It looked as though the downtrend might have been broken. A double vertical includes two separate bullish vertical spreads. A Bull Put spread is put on at strike prices below the current price. This will generate a credit since the higher strike put will bring in more than the lower strike put costs.
As long as the stock remains above the strike prices this credit will be ours to keep. The second part of a double vertical spread is a bull call spread at higher strike prices. These strikes are selected so that the cost of this spread is less than the credit received for the bull put spread while still being within a price range that the stock might exceed.
This seemed well within the realm of possibility.
Directional Trading: Manage Risk With Vertical Spreads - Ticker Tape
And if that bull call spread did payoff, that would also mean the bull put spread, at the lower strikes, was a winner. This maximum profit could also be calculated in a different way by figuring the maximum profit of the two spreads as standalone trades.
Below is the option payoff chart for this trade. Notice its unusual shape.
The three curved lines represent the profit or loss on this trade at different dates before expiration: The close grouping of the curved lines shows that the trade is not affected much by the passage of time up until two months out. At any price above that at expiration we would have a profit.
When a trade generates a credit it is always possible that unfavorable price movement of the stock will cause us to have to give back all of that credit plus more. This would be the buying power needed. Not likely, but possible. If this trade is still in place in two months our management will depend on where the price is at that time. At some price levels the trade will be short time value; and time will be our friend.
At other prices the trade will be long time value which will then be rapidly declining.
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