Spreads Flashcards
Spread
Multiple option positions in which the investor buys one option and sells another (both puts or calls) on the same underlying security with different expirations and/or different strike prices.
Debit Spread
If the long position has a higher premium than the short position, the investor has established a debit spread.
Credit Spread
If the short position has a higher premium than the long position, the investor has established a credit spread.
Analysis of Price Spreads
Whether a spread is bullish or bearish is determined by examining the leg of the spread with the larger premium. If the option position is bullish, the spread is bullish. If the position is bearish, the spread is bearish.
BULLISH: Net Debit Call Spread
- Greater premium is associated with the long call and purchasers are bullish.
- Investor wants the spread to widen
- Maximum gain is the difference in strike prices minus the net debit spread.
- Maximum loss is the net debit spread
BULLISH: Net Credit Put Spread
- Greater premium is associated with the short put and sellers are bullish.
- Investor wants the spread to narrow.
- Maximum gain is the net credit spread.
- Maximum loss is the difference in strike prices minus the net credit spread.
BEARISH: Net Credit Call Spread
- Greater premium is associated with the short call and sellers are bearish.
- Investor wants the spread to narrow
- Maximum gain is the net credit spread.
- Maximum loss is the difference in strike prices minus the net call credit spread
BEARISH: Net Debit Put Spread
- Greater premium is associated with the long put and purchasers are bearish.
- Investor wants the spread to widen.
- Maximum gain is the difference in strike prices minus the net debit spread.
- Maximum loss is the net debit spread.
Call Price Spread - Breakeven
The breakeven point of a call price spread (debit or credit) is found by adding the net premium to the lower strike price.
Put Price Spread - Breakeven
The breakeven point of a put price spread is found by subtracting the net premium from the higher strike price.
Breakeven points for price (vertical) Spreads
CALL DEBIT SPREAD:
Lower Strike Price + Net Debit
Example 1 Buy July 80 Call 7.50 Sell July 90 Call 3.25 ----Net Debit----- 4.25 80 + 4.25 = 84.25 If at expiration the price is 84.25, the gain on 90 call (the premium of 3.25) offsets the 3.25 loss (the premium of 7.50- the in the money amount of 4.25) on the 80 call. Profits are made above 84.25, reaching a maximum of 5.75 when the share price is 90. Losses are realized below 84.25, reaching a maximum of 4.25 when the strike price is 80.
Breakeven points for price (vertical) Spreads
CALL CREDIT SPREAD:
Lower Strike Price + Net Credit
Example 2 Sell July 80 Call 7.50 Buy July 90 Call 3.25 ----Net Debit----- 4.25 80 + 4.25 = 84.25 If at expiration the price is 84.25, the gain on the 80 call (7.50-4.25=3.25) offsets the loss on 90 (3.25)call. Losses are realized above 84.25, reaching a maximum of 4.25 when the strike price is 80.
Breakeven points for price (vertical) Spreads
PUT DEBIT SPREAD:
Higher Strike Price - Net Debit
Example 3 Buy 90 Put 9.00 Sell 80 Put 3.00 ----Net Debit----6.00 90 - 6 = 84 If at expiration the price is 84, the gain on the 80 put (3.00) offsets the 3 point loss (9 - 6) on the liquidation of the 90 put. Profits are made below 84, reaching a maximum of 4 when the share price is 80. Losses are made above 84, reaching a maximum of 6 when the strike price is 90.
Breakeven points for price (vertical) Spreads
PUT CREDIT SPREAD:
Higher Strike Price
Example 3 Sell 90 Put 9.00 Buy 80 Put 3.00 ----Net Debit--- 6.00 90 - 6 = 84 If at expiration the price is 84, the gain on the 90 put (9 - 6 = 3) is offset by the loss on the 80 put (3.00). Profits are made above 84, reaching a maximum of 6 when the strike price is 90. Losses are realized below 84, reaching a maximum of 4 when the strike price is 80.
Butterfly Spread
Consists of two spreads established simultaneously, one bull spread and the other bear spread. The resulting position is neutral, that is, the investor will profit in the stock is stable.
