Ready to Go Vertical? Options Spreads with Versatility

Ready for a more advanced options trading strategy? We explain vertical spreads (credit and debit).

Print
https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Vertical stripes: Vertical options spreads provide a versatile strategy
4 min read

Feeling pretty experienced with trading long calls, long puts, and writing covered calls? Vertical spreads are one of the building blocks of options trading, and they can be a logical next step.

Depending on its construction, a vertical spread can be either bullish (benefiting from a rise in the underlying’s value) or bearish (benefiting from a decrease in the underlying’s value). If you’re looking for an option strategy that is designed to take advantage of directional moves but with defined risk, the vertical spread could be the answer.

There are different types of vertical spreads, but their mechanics are similar. A call vertical, for example, involves simultaneously buying one call option and selling another call option at a different strike price in the same underlying, with the same expiration. Likewise, a put vertical involves simultaneously buying a put option and selling another put option at a different strike price in the same underlying, with the same expiration.

Among call and put vertical spreads, there are two types: credit and debit. To create a credit spread, traders sell an option with a high premium and buy an option with a low premium. To form a debit spread, traders purchase a high premium option and sell an option with a low premium.

The Credit Spread

The risk in a vertical credit spread is determined by the difference between its strikes minus the credit received, plus transaction costs. The maximum potential profit for a vertical credit spread is the premium collected when selling the spread, minus transaction costs. For example, if a trader sells an XYZ 102/104 call vertical for $0.60, the risk is $140 per contract and the maximum potential profit is $60 per contract, minus transaction costs. See figure 1.

Vertical credit spread characteristics:

  • Risk per contract = (Difference between the strikes – credit received) x 100, plus transaction costs
  • Max profit per contract = Credit received x 100, minus transaction costs

For the XYZ example:

  • Risk = $140, or ($2.00 – $0.60) x 100, plus transaction costs
  • Breakeven level = $102.60, or $102 (the short strike) + $0.60 (credit received)
  • Max potential profit = $60 ($0.60 x 100), minus transaction costs
Vertical option credit spread profit and loss

FIGURE 1: VERTICAL CREDIT SPREAD PROFIT AND LOSS.

This profit and loss graph shows max loss, breakeven, and max profit for an XYZ 102/104 credit spread. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

The Debit Spread

When buying a vertical debit spread, the risk is the premium paid for the spread. The maximum profit is determined by subtracting the premium paid from the spread between strike prices, minus transaction costs. For example, if a trader buys a FAHN 210/207 put vertical for $1.20, the risk is $120 per contract plus transaction costs and the maximum potential profit is $180, minus transaction costs. See figure 2.

Vertical debit spread characteristics:

  • Risk per contract = Amount paid for the spread x 100, plus transaction costs
  • Max profit per contract = (Difference between the strikes – amount paid for spread) x 100, minus transaction costs

For the FAHN example:

  • Risk = $120 ($1.20 x 100), plus transaction costs
  • Breakeven level = $208.80, $210 (long strike) – $1.20 (the debit paid for the spread)
  • Max potential profit = $180, or ($3.00 – $1.20) x 100, minus transaction costs
Vertical option debit spread profit and loss

FIGURE 2: VERTICAL DEBIT SPREAD PROFIT AND LOSS.

This profit and loss graph shows max loss, breakeven, and max profit for a FAHN 210/207 debit spread. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

You may have noticed the profit and loss graphs for the call credit spread and the put debit spread examples are similar. This is because they are both bearish, risk-defined spreads. 

Versatile Verticals

Now that you understand the basic characteristics of vertical spreads, let’s talk about their versatility. The vertical spread is a directional play that enables an options trader to express a bullish or bearish view. It can also be used to take advantage of relatively high or low volatility levels.

Let’s say an options trader thinks a stock is oversold and volatility levels are due to decrease. In this case, selling an out-of-the-money vertical put credit spread might be appropriate. Selling a vertical put credit spread is a bullish strategy that seeks to profit from a rise in the price of the underlying as well as a decrease in volatility. 

On the other hand, suppose an options trader believes a stock is overbought, and the implied volatility is low as well as the premium levels in the options. This might be a good time to buy an at-the-money vertical put debit spread. This is a bearish strategy that seeks to profit from a fall in the price of the underlying as well as an increase in volatility.

These are just a few of the ways that vertical spreads can be used to place directional trades on an underlying stock in a risk-defined manner. Next time you believe an underlying is poised to make a move, consider using a vertical spread to potentially capitalize on your idea.

2 Strategies for 2 Months*

Get step-by-step TradeWise trade ideas from former floor traders delivered directly to your inbox. At checkout, enter coupon code "ticker."

Call Us
800-454-9272

*When the two months have passed, keep the TradeWise service for just $20 per strategy per month.

TradeWise Advisors, Inc. and TD Ameritrade, Inc. are separate but affiliated firms. Advisory services are provided exclusively by TradeWise Advisors, Inc. and brokerage services are provided exclusively by TD Ameritrade, Inc. For more information about TradeWise, please see ADV 2 on www.tradewise.com.

Spreads, straddles, and other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return. These are advanced option strategies and often involve greater risk, and more complex risk, than basic options trades.


adChoicesAdChoices

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.

Scroll to Top