DEFINITION of Option spread
An option spread is a strategy used in options trading. Option spreads are the basic building blocks of many options trading strategies
WHAT IT IS IN ESSENCE
A spread position is entered by buying and selling the equal number of options of the same class on the same underlying security. But with different strike prices or expiration dates.
There are three main classes of options spread used by traders:
Vertical spreads or money spreads have identical underlying security, same expiration month, but different strike prices.
Horizontal spreads or calendar spreads have identical strike prices but different expiry dates.
Diagonal spreads have same underlying security but different expiry dates and strike prices. They have name diagonal spreads because they are a combination of vertical and horizontal spreads.
Traditional options spread strategies involve buying and selling equal numbers of options contracts. When this isn’t the case, it is called a ratio spread or a backspread.
Different option spread strategies suit different options traders.
HOW TO USE
In options trading, an option spread is the formation of the simultaneous purchase. And the sale of options of the same class on the same underlying security but with different strike prices and/or expiration dates.
Any spread that is constructed using calls can be referred to as a call spread.
Similarly, put spreads are spreads created using put options.
Option buyers can consider using spreads to reduce the net cost of entering a trade. Naked option sellers can use spreads instead to lower margin requirements.
So as to free up buying power while simultaneously putting a cap on the maximum loss potential.
Spread option trading is a technique that can be used to profit in bullish, neutral or bearish conditions.
It basically functions to limit risk at the cost of limiting profit as well.
Spread trading is opening a position by buying and selling the same type of option.