The spread describes trades with two or more options having different strike prices. There are eight types of spreads and, among these, several additional variations.
1. Different strike, same expiration, the vertical spread. The vertical spread is one where each side expires on the same date, but involves different strike prices. This is often the favored choice when current market value is halfway between two strikes.
2. Different expiration, same strike, the horizontal spread. If you like the idea of opening a position with segments expiring on different dates, the horizontal spread is worth considering.
3. Different expiration and different strike, the diagonal spread. Combining the previous two types, the diagonal spread consists of positions with different expiration dates and different strike prices.
4. Long spreads. Spread can consist entirely of long calls and/or long puts in vertical, horizontal or diagonal versions. This is appropriate for those with minimal approval levels or for traders not willing to go short.
5. Short spreads. A spread can also be made up of short positions, in vertical, horizontal or diagonal configurations. The call sides can be covered or uncovered; and the put side can be naked or covered with later-expiring long positions.
6. Call only or put only spreads. You can also limit your spreads to the use of calls only or puts only. Depending on where the strikes fall, either decision can be long or short, and also can be either bullish or bearish.
7. Combining calls and puts. Complicating matters even more, spreads can be made up of a combination of calls and puts - these can be long or short and bullish or bearish, as well as designed as vertical, horizontal or diagonal.
8. The weighted spread. The spread can also involve more positions on one side than the other, creating emphasis on bullish or bearish movement.
Spreads offer flexibility when used in synthetic positions. These are incredible strategies that can be tailored to suit any risk profile. Spread risks vary based on the mix of long or short, time to expiration, and proximity between price and strike. But the spread is not a singular format strategy: the varieties are practically endless.
Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com.