Tuesday, October 2, 2012

Spread Types

Credit Spreads: (Bull Call Spread, Vertical Debit Call Spread)

Give you maximum credit on day one and you carry that obligation until trade closure or expiration. Losses that are not riskmanaged can be staggering. These are typically set up so that the price must do nothing, or at least move AWAY from the spread in order to profit.

You are bullish on the underlying instrument.
This is a Long Vega trade.

Buy a front month Call option that is slightly in the money and to help reduce your cost basis, you sell a front month Call option somewhat out of the money.

Credit spreads are always “Negative” or “Short” Gamma” positions. This feature of Gamma works against the position as price gets closer to your short strike.

Bull Put Spread Construction:

     Buy 1 OTM Put (cheaper)
     Sell 1 ITM Put   (expensive)

Debit Spreads:
Require cash to set up on day one however your maximum risk is normally limited to your initial investment. Profits can be several times what your initial investment was. These are usually set up so that the price must MOVE for you to profit.