Follow Terry's Tips on Twitter. Like Terry's Tips on Facebook. Watch Terry's Tips on YouTube. A vertical spread is simply the purchase of an option and simultaneous sale of another option at different strike prices same underlying security, of course. A vertical spread is a known as a directional spread because it makes or loses money depending on which direction the underlying security takes.
You buy a vertical spread if you have a feel which way the market for a particular stock is headed. You can buy a vertical spread if you think the stock is headed higher, or a different vertical spread if you believe it is headed lower.
A neat thing about vertical spreads is that if the stock doesn't move at all, you might just make a gain even if it didn't do exactly what you had hoped.
Here is an example of a vertical spread I recently placed. I had a good feeling about Apple. I thought the stock would go up in the next month, or at least not fall very much. I only had to come up with the difference between the cost of the option and the proceeds from the option I sold.
I bought this spread with calls, but the potential gains or losses would have been identical if I had used puts instead. In vertical spreads, the strike prices are what is important, not whether puts or calls are used. On the third Friday of March, both options would expire. In retrospect, I would have been smarter to buy the vertical spread using puts rather than calls if the same price for the spread could have been had.
If I used puts, I would buy at the same strike prices buying the puts and selling the puts. When you buy a credit spread like this, the broker places a maintenance requirement on your account to protect against the maximum loss that you could incur.
A maintenance requirement is not a margin loan. No interest is charged. The broker just holds that amount aside in your account until your options expire. There are several reasons that I would have been smarter to make this trade in puts rather than calls. Second, selling a vertical bullish spread in puts means that I would be taking in more cash than I paid out i.
The extra cash in my account would be credited against a margin loan I might have in my account, thus saving me some interest there is no interest charged on a maintenance requirement.
Third, buying a vertical put spread eliminates the possibility of an early exercise of a short in-the-money call - such an exercise might take place if the company declares a dividend during the holding period of the spread, or if the call gets so far in the money that there is no time premium left, and the owner of the call decides to take stock.
For all these reasons, put spreads are the best bet for vertical spreads when you expect the stock price to rise, assuming, of course, that they can be placed for the same price as the equivalent spread in calls. The risk profile of each spread is the same, so the least expensive alternative should be taken, and if both put and call spreads are identical, then puts should be the spread of choice.
We use this list in one of our portfolios to spot outperforming stocks and place spreads that profit if the momentum continues, at least a little.
We use this list in one of our portfolios to identify stocks with momentum and place spreads that profit if the momentum continues, at least a little. I would also like to include a table which reviews how the previous 12 Trading Idea of the Week selections have worked out in the real world.
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Please read Characteristics and Risks of Standardized Options before investing in options. Vermont website design, graphic design, and web hosting provided by Vermont Design Works. Vertical Spreads All About Vertical Spreads - Definition, An Example, and How to Use A vertical spread is simply the purchase of an option and simultaneous sale of another option at different strike prices same underlying security, of course.
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