Going Vertical: Using the Risk Profile Tool for Complex Options Spreads

If you’re an option trader using the thinkorswim^® platform from TD Ameritrade, odds are you’re familiar with the Risk Profile tool. Not only can it provide a single visual risk snapshot, but it can also help you estimate changes in a trade’s profile given certain changes in risk components such as time and volatility. From the basic long call option to a complex, multi-leg ratio spread, think of the Risk Profile as the Swiss Army knife of options analysis.

Ready to see it in action? Let’s start with a vertical spread—the purchase of a call or put option, paired with the sale of another call or put of the same expiration month, but with a different strike. (Need a refresher? Read about the basics of vertical spreads and selling vertical credit spreads.)

The following, like all of our strategy discussions, is strictly for educational purposes. It is not, and should not be considered, individualized advice or a recommendation.

Make That Vertical Leap

Building a vertical spread using the Risk Profile tool is about as simple as entering a one-leg order such as a long call—there are just a couple selections to make. On the Analyze tab, select Add Simulated Trades and enter your ticker symbol. Start by right-clicking on a strike that you'd like as part of your vertical spread and then select Analyze buy trade or Analyze sell trade (see figure 1). This will bring up a menu of spread choices. Select Vertical (or whatever’s your spread du jour).

As an example, we’ll analyze selling the 105-100 vertical put spread, which is the sale of the 105-strike put and the purchase of a 100-strike put. In our example we’re selling the spread for a credit of $0.61 (times the options multiplier of 100 = $61, minus transaction costs).

To get the visual display of the simulated trade, under the Analyze tab, select the Risk Profile subtab (right next to Add Simulated Trades). You’ll see a chart of potential outcomes for the trade (see figure 2). Remember that this is an estimation based on theoretical values; trades in the real market might perform differently.

Scenarios and the Numbers Behind Them

The blue line in figure 2, which represents the profit and loss (P&L) of the trade at expiration, has two kinks in it. Those are the strike prices of the spread. The purple line is the estimation of the spread’s P&L as the price of the underlying changes. For instance, if the underlying were to go to $107 today (1), the trade would be down about $47. But then if the underlying remained at that level until expiration (2), the trade could end up making $61. Both legs would expire worthless, and you’d keep the premium minus transaction costs.

The graph demonstrates how the passage of time helps this trade if the underlying stays above the high strike of 105. However, if the underlying drops to $96 today (3) and stays there until expiration (4), today’s loss of about $300 would become a full loss of $439 by expiration. Why? Because if both strikes finish in the money, you’ll be assigned a long stock position at $105 per share and you’ll exercise your 100-strike put, selling your stock at $100 per share and essentially locking in a $5 loss. But you collected a $0.61 credit when you sold the spread, so your net loss would be $4.39 times the contract multiplier of 100, or $439, plus transaction costs.

And remember, you can analyze the trade using other future dates prior to expiration, and at other levels of implied volatility, by using the Lines and Step buttons.

Do you have multiple positions within that same stock? Do you have a position in the stock itself? A complex, multi-leg spread? More than one expiration date? This tool can give you a single visual display.