An option spread is created when a trader simultaneously buys and sells options with different strike prices and/or expiration months. A vast variety of strategies can shape the risk and reward of the trade. Simple spreads have two legs and the months are the same and the options are of the same class (calls or puts). The quantity is also the same and one leg is a purchase and the other is a sale. These spreads are referred to as vertical spreads because the expiration month is the same. They can be bullish or bearish. The trader creates a spread to reduce the risk exposure and the margin requirement. When option implied volatility is very high, spreads are an effective way to defray the expense of the long leg. Credit spreads, debit spreads, bullish put spreads, bearish put spreads, bullish calls spreads, and bearish calls spreads are all examples of simple spreads. Complex spreads have three or more legs and the quantities and/or expiration months can be different. Diagonal spreads, butterfly spreads, calendar spreads, iron condors, ratio spreads and back spreads are some of the more common strategies. Complex option spreads tend to be non-directional and they require an extensive understanding of options.
January 2, 2009
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