Some vertical spreads have the same looking risk profile. There's a reason why that may be the case. Here's an example of a vertical debit and credit spread options trade.
Understand when you should make a debit or credit spread
Know how to look up risk profiles on the thinkorswim platform
There are a lot of moving parts to trading options. The education coaches at TD Ameritrade can be a great resource to get all your questions answered.
Hey Coach! I’ve got my directional expectations laid out, my endpoints set, and I’m ready to place a vertical spread trade. Do I make a debit or credit spread? Should I trade calls, puts, or a combination?
You might be surprised to learn that, sometimes, it’s the same trade, with the same basic risk profile.
Consider the set of options strikes and theoretical values (TVs), where the underlying stock is trading at $240 (see table below).
Suppose you think the stock will rise $5 before the options expire. Should you buy the 240 calls and sell the 245 calls (call vertical) or sell the 245 puts and buy the 240 puts (put vertical)? The “risk profile”—points of max profit, max loss, and breakeven—is the same for both. Not a believer? See for yourself.
Fire up the thinkorswim® platform, pick a call strike, and select Analyze > Buy Trade > Vertical. Have a look at the Risk Profile under the Analyze tab. Now repeat the process, but instead of the long call vertical, pull up the short put vertical with the same strikes. Look familiar?
Although the expiration risk graphs look the same, the payout dynamics aren’t. With the long call vertical, you initially lay out $2.85 in premium, with a max payout of $2.15 ($5 as the difference between the strikes, minus the $2.85 debit) if the stock is at or above $245 at expiration. If you were to instead sell the put vertical, you’d collect the premium of $2.15 up front, with the max loss of $2.85 if the stock is at or below $240 at expiration. (Note: For simplicity’s sake, these examples don’t include transaction costs, and they assume the theoretical value is the trade price, without any bid/ask spread.)
Here’s another example. Did you know that a butterfly or condor (made up of all calls or all puts) has the same risk profile as its “iron” equivalent (iron butterfly or iron condor, made up of a short call vertical paired with a short put vertical)?
Punch one up in thinkorswim to see for yourself. Again, although the risk graph is the same, the payout dynamics differ. For example, buying the 235/240/245/250 call condor would require an up-front debit of $0.65 ($17.20 + $8.50 – $13.95 – $11.10), whereas you could initiate the 235/240/245/250 iron condor for a credit of $4.35. Check the platform to analyze the payout scenarios.
Options are about flexible, targeted exposure. And depending on your objectives, there’s often more than one way to get there.
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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
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