What is an Options Spread?
- An options spread is an options trading method that involves the simultaneous buying and selling of options contracts.
- The strike prices and expiration dates of these contracts vary. Option spreads can be created by combining different call options, put options, or both.
- Vertical spread and synthetic spread are the two popular option trading strategies.
What Do You Mean by Vertical Options Spread?
- The vertical options spread is a direction-based options strategy wherein the acquired and sold options are of the same type, i.e. either call or put.
- However, the long and short options have two distinct strike prices.
- Here, 'vertical' refers to the position of the strike price purchased and sold, with one lower and another higher. Whereas the variance between the strike prices of the two options is known as 'spread width'.
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What are the Different Types of Vertical Options Spreads?
The vertical options spread can be categorised under four main themes. Each provides investors with a risk-reward profile they can adjust to their risk tolerance and the persisting market conditions. However, the four categories need to have the same expiration date as a necessity. These four themes are:
- Bull call spread: It involves buying a call option with a lower strike price and selling another call option with a higher strike price at the same time.
- Bear call spread: It involves selling a call option with a lower strike price and buying another call option with a higher strike price at the same time.
- Bull put spread: It involves selling a put option with a higher strike price and buying another put option at a lower strike price at the same time.
- Bear put spread: It involves buying a put option, having a higher strike price and selling another put option at a lower strike price at the same time.
How are Vertical Options Spreads Useful?
- As debit spreads, they lower the premium amount that needs to be paid. It partially compensates for the expense with the premium received on the sold option.
- As credit spreads, they reduce the risk of an option position. It earns a net credit, giving immediate income and a safety net against possible losses.
What Do You Mean by Synthetic Options Spreads?
- A synthetic options spread is a mix of different options positions — long or short, call or put.
- It is combined with the underlying security (cash position), future position, or both.
- The main goal is to maximise profits by combining cash positions, options, and futures.
What are the Different Types of Synthetic Options Spreads?
The synthetic options spreads can be categorised under four main themes. Each category can be customised to meet unique market expectations. The four categories must have the same expiration dates and strike prices. These are as follows:
- Synthetic long future: It involves combining a long call option with a short put option when investors expect a positive market trend.
- Synthetic short future: It involves combining a short call option with a long put option when investors expect a negative market trend.
- Synthetic long call: It involves combining a long stock position with a long put option to maximise profit from the underlying asset’s potential price increase.
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Synthetic long put: It involves combining a short stock position with a long call option to minimise loss from the underlying asset’s potential price decline.
How are Synthetic Options Spreads Beneficial?
- With synthetic options spreads, investors can experiment with various investment strategies without putting in a considerable amount of money.
- Additionally, synthetic positions allow investors to profit from market trends while successfully controlling risk.
Vertical Options Spreads vs. Synthetic Options Spreads
- Investors who want to navigate the options market with ease can benefit from using either of these strategies.
- These methods offer flexibility and customisation options.
- However, it is important to conduct a thorough analysis of potential risks and opportunities before implementing them in real investment scenarios.
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