Spreads

Every year around Super Bowl time, you might hear about something called the spread offense. The idea is to spread your playmakers out and force the defense to spread itself out as well, giving the quarterback more opportunities to make plays. If your offense relies too much on one playmaker, the defense can easily stop him wherever he is. But in a spread offense, if too many defenders go to one spot, you’ve got playmakers on the other side ready to take advantage.

Believe it or not, there’s something similar in Options Trading. Option spreads work by putting multiple options over a range of strike prices, which keeps the risk and reward of the trade within a predictable range. This allows investors to strategically capitalize on market opportunities. Spread trading has its own unique set of risks, but investors who use spreads can establish positions with defined risk, that benefit in specific market environments. *

Examples

For instance, let’s look at a bullish call spread. Designed to profit in a rising market, it’s established by going long a call at a lower strike price, while selling a slightly higher out-of-the-money call to reduce the net cost of the trade. If the price of the underlying goes to the high end of your spread, you can be assigned on the option you sold at that strike. But your long call option at the other end of the spread is there to offset it. If done right, it should allow you to buy the shares at the lower strike price and sell them at the higher price for a profit.

Conversely, an investor who aims to capitalize in a down market could place a bearish put spread. By going long a put and selling a lower strike-price put option, the bearish put spread reduces the overall cost of the bearish bet. For this spread, if the price of the underlying moves to the low end of the spread, you may be assigned on the short leg, and have to buy the shares at the lower strike price. But your long put option at the high end of the spread is there to offset it. Just like the bullish call spread, if done right, this spread should allow you to buy the shares at a lower price, and sell them at a higher price for a profit.

Tradeoffs

A bullish call spread has a lower maximum profit potential than a single long call position, but the benefit is that it doesn’t cost as much. Investors who want to capitalize on an upside movement but do not want to risk as much can use a bullish call spread. Likewise, a bearish put spread has a lower maximum profit than a single long put option. The profit potential is limited to the width of the strike price less the overall costs, but investors do not have to risk as much capital as compared to when going long just a single leg put.

More Examples

Spreads can also be used to earn income by selling options to collect their premiums. In a rising market, investors can place bullish put spreads by selling out-of-the-money puts while purchasing lower strike-price puts to hedge the downside risk. When markets are expected to fall, investors can place bearish call spreads by selling a call option and purchasing a higher strike price call option. If the options settle out of the money by the expiration date, the investor keeps the premium earned from the sale. These income generating spreads have defined risks if the trade goes the other way, with its max loss capped at the width of the spread, less the credit.

In all of these examples, having a single-leg option position is like relying on one receiver. It might work out, but the risks are higher, and it gives you less maneuverability. Adding a second option—or another playmaker—opens up more opportunities on the field and in the market.

To read more about bullish and bearish spreads as well as credit spreads, condors, butterflies, and calendar spreads, head on over to our learning center to read more.

• Bull Call Spread: https://www.webull.com/learn/courseware/uzXC1A/Bull-Call-Spread?courseId=HRwsEk 
• Bear Put Spread: https://www.webull.com/learn/courseware/73RGB7/Bear-Put-Spread?courseId=Hu2Nlw 
• Bear Credit Spreads: https://www.webull.com/learn/courseware/rGnBaq/Bear-Call-Spread?courseId=Hu2Nlw 
• Bull Credit Spreads: https://www.webull.com/learn/courseware/X3Kfck/Bull-Put-Spread?courseId=HRwsEk 
• Long Butterfly Spread: https://www.webull.com/learn/courseware/EyhtZy/Long-Call-Butterfly?courseId=Hy1zs7 
• Long Call Calendar Spread: https://www.webull.com/learn/courseware/5l1UiQ/Long-Call-Calendar-Spread?courseId=Hy1zs7 

Also, to learn more about the nuances of option trading risks make sure to read our FAQ on Option Assignment Risks: https://www.webull.com/help/faq/10614-Option-Expiration-Exercise-Assignment-and-the-Potential-Risks