When options traders or investors engage in spread strategies, they are often working with vertical spreads.
Any margin is created when a person buys and sells call options on the same stock or buys and sells put options on the same stock.
A vertical or price spread gets its name from the vertical movement of prices. In this option strategy, the strike prices are different but the months are the same.
vertical vs. horizontal
A horizontal spread is when the strike prices are the same, but the months are different. They are also called calendar sheets. A vertical strategy is the opposite. The months are the same, but the option strike prices are different.
The strategy behind this is to make money from the potential strike price difference or premiums, if a premium profit was made. All spreads boil down to premium gain vs. trade or exercise potential. Verticals can be credit or debit.
debit margin
When a spread is created and the investor has lost money on premiums (more money was spent buying than selling), it is a debit spread. Since money was lost on the options, the investor will lose money if the options expire worthless (which is possible). The only way a debit margin holder can benefit is by extending or exercising options. Extension refers to premiums growing and contracts becoming valuable enough to be traded later. A vertical debit spread tells the trader that these contracts are to be traded or exercised for profit.
credit spread
When a margin is established and the investor has made money on the premium, it is a credit margin. The profit here remains with the options expiring worthless and the person earning the premium as the maximum profit from him. A vertical credit spread is a strategy that does not work if the options are exercised. The strike prices would be reversed, earnings wise.
examples
Buy 1 WEF Oct 60 Call for $500
Short 1 WEF Oct 70 Call for $200
This is a vertical or price spread because the strike prices are different. It is also a debit, because the premiums have resulted in a loss of $300. This is also a bullish spread. It is bullish because the trader needs the market to go higher, hoping that the options will be exercised. The buy call gives you the right to buy the stock at 60 and the short call carries the obligation to sell the stock at 70. This potential 10-point gain on the stock is why someone would create a vertical debit spread. If the options expire, the maximum loss would be $300.
Buy 1 GHF on April 30 Call for $600
Short 1 GHF April 20 Call for $900
This is a price or vertical spread as well, but it is a credit spread. He is also a bass player. Strike prices are not attractive to this investor, as he will suffer a loss of 10 points if they are struck. The goal here is for the stock to decline and the vertical options to expire. Credit spreads are always bearish.
These and all distribution strategies are most effective when it comes to profits, when working with stocks you are familiar with. Knowing the trading ranges and pricing habits of their stocks can make them attractive candidates for options or vertical spreads.
Learn more about stock options trading HERE
Good luck!