A spread is a trading strategy in options trading that involves two long or short options together. Spreads can be arranged in several ways by adjusting their strike prices for long or short positions, volatility, and expiration dates. In that sense, Options spreads give you more control and choice over options trading. However, these strategies can be difficult to execute.
Put Spreads and Call Spreads are two types of Options spreads. These spreads fall in the credit spreads category. These spreads are created by simultaneously taking two long or short positions are different strike prices. Different strike prices create a “spread”. It means there is one premium being received and one is paid. The trader can offset the premium costs to make profits. Also, a trader will make a profit if the underlying asset moves favorably.
A call spread is a vertical spread options strategy. It involves buying and selling two call options at the same expiry date but with different strike prices. The strike prices are chosen with a strategy to anticipate the market behavior. These spreads can be arranged in a bull call or bear call spread combination.
How Does a Call Spread Work?
A trader who is bearish on the market can take a bear call spread position. Contrarily, the trader can take a bullish call spread as well. Both of these spreads involve taking a long and a short position simultaneously with different strike prices.
Bear Call Spread
If a trader expects a decline in an asset’s price, it can take a bear call spread. It is also called a bear credit spread.
In a bear call spread, the trader will purchase a call option at a certain strike price and simultaneously sell another call option at a lower strike price with the same expiration dates. Simply, a trader will buy higher and sell lower with a bear call spread.
Bull Call Spread
Contrarily, if a trader thinks an asset’s price will move up, it can take a bullish call spread.
In a bullish call spread, a trader will purchase a call option at a lower strike price and sell another call option at a higher strike price. Both options must have the same expiry dates. It means a trader will buy low and sell high in a bullish call spread.
Suppose a stock is trading at $50. You can buy a call option at $40 with a premium of $1.0, and sell another one at $35 with a premium of $2.0.
You’ll receive a net premium of $1 per contract i.e. $100 if both options lapse. Hence, your maximum profit will be if the stock price closes at $35. Below that point, there will be no additional profit.
If the stock price moves above $40, you’ll incur a net loss. Hence, in a call spread the maximum profit is the difference between two premiums. The maximum loss is the premium paid plus the loss on strike prices.
A put spread is another options trading strategy that involves buying one put option at a certain strike price and selling another put option with a different strike price. However, both put options must have the same expiry dates.
How Does a Put Spread Work?
Similar to call spreads, a trader can take a bullish or bearish take on put options. Put spreads are less risky options than trading simple options on an underlying asset. In a worst-case scenario, the trader will reduce the cost of trading two options by receiving a premium for selling one option.
Bear Put Spread
In a bear put spread, a trader buys one put option at a higher strike price and sells another put option with a lower strike price. Both put options must have the same expiration dates though.
A trader hopes to make a profit if the underlying asset’s price falls. The maximum profit arises in a bear put spread if the underlying asset’s price falls below the strike prices of both put options.
Bull Put Spread
In a bull Put Spread, a trader buys one put option at a certain strike price and sells another with a slightly higher strike price. Both put options should have the same expiry dates.
The trader hopes that the underlying asset’s price increases and the sold put option expire. If the sold put option expires, the trader will keep the premium received for it. Hence, a trader will make a profit if both options expire.
Suppose a stock is trading at $50. You can buy a put contract for $55 with a premium of $5. Now, sell another put for $45 and a premium of $3. Your net premium is $2 per contract i.e. $200.
If the stock moves below $45, both options will be in the money, and you’ll make a profit. Your net profit will be the difference of premiums plus the difference of exercised put options.
If the stock moves above $ 55, you’ll incur a loss of total premium that is $200. If the stock price remains below $50 and above $45, you can still break even with some profit.
Key Differences in a Call Spread Vs Put Spread
A call spread and a put spread can be used in options trading. Both are used to maximize profits by simultaneously taking two long or short options.
Here are some key differences between a call spread and a put spread.
|Feature||Call Spreads||Put Spreads|
|Meaning||A right to buy options Contracts||A right to sell Options Contracts|
|Trader Anticipation||A Rise in the Prices||Fall in the Prices|
|Types||Bull and Bear Calls||Bull and Bear Puts|
|Profits||Potentially unlimited profits||Potentially limited Profits|
|Cash||Does not Require upfront cash||Requires upfront cash|