Introduction to Option Vertical Spreads
In the basic strategies section, we covered the 4 basic option trading techniques and amongst the four were two strategies (short call and short put) that had unlimited risk exposure. In addition, you may have also realized that buying call or put options can get very expensive, especially if they expire month after month.
To counter these two areas (cost of option and unlimited risk of short options), one could use vertical spreads. A vertical spread is a combination of two options (same type) with different strikes expiring in the same month. The 4 basic vertical spreads are as follows:
Each of the four spreads described above has limited risk exposure and reward potential. Additionally, spreads can be traded for a lower cost than straight calls and puts. In trading vertical spreads, we give up some profit potential to limit our risk exposure and this trade-off is critical in options trading because managing RISK is everything!!
Spreads also form the foundation for all other advanced option trading strategies and I personally use vertical spreads on a daily basis. As a start, click here to read about how the the bull call spread functions.
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