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Vertical Spread – Favorite Strategy Of Option Pros

A preferred non directional trading strategy is the option Vertical Spread. This strategy is one of the easier option spreads to comprehend for newer option traders. In addition it is simple to place and there is not much to do management wise while the trade is in play – which allows the vertical spread trader to be freed from their trading chair and not have to watch every up tick and down that the market makes all day.

A core trading strategy that is found within many of the other option trading strategies like the butterfly trade which is constructed from a vertical spread and a debit spread, and also the iron condor which is built from two separate credit spreads placed on either side from where the stock or index being used is trading at.

Option traders love to trade this strategy because the way these trades are constructed can allow the trader to be wrong and still make money. If the trader creates a particular credit spread position, he or she can win if the stock or index being traded winds up doing three out of four possible scenarios. If the stock goes down, the trader makes money. If the stock goes nowhere the trader makes money. If the stock goes up a little, the trader makes money. The only way the trader can lose money if the stock goes up far enough to threaten the vertical spread that has been sold. And even then, there are management and adjustment techniques that can be utilized to hedge against losses.

For example let’s say our trader is bearish on the stock XYZ. XYZ is trading at a recent high and our trader believes that the stock will not move any higher over the next 30 days. So, he sells a bear call spread – a call option vertical spread that benefits in a neutral to bearish scenario.

This trade can win in 3 of 4 possible stock movement scenarios by using this option spread. If the stock drops like our trader thinks it will, the spread trade wins. If the stock doesn’t move up or down – just stays pretty much in the same area as it currently, the spread wins. Even if the stock moves upwards – defying what our trader believes will happen – this spread trade could still be profitable – as long as it doesn’t move above a certain level. So, in each of these scenarios, this trade would be profitable. The only way they would not be profitable is if the stock moves up past the level that has been sold – in which case the trader would then need to either remove the trade for a possible loss – or adjust the trade in an attempt to make it profitable once more.

Vertical Spread Strategies

The iron condor option strategy is made up of two vertical spreads – a vertical call spread and a vertical put spread.

Spread Option

From the numerous non directional trading strategies, perhaps the spread option that is currently discussed most is the credit spread – also known as the vertical spread. This strategy is considered by many to be more along the lines of an “entry level” strategy for option traders. It is a strategy that is straightforward and uncomplicated – at least more so than some option strategies such as the iron condor and the double diagonal – as well as the option butterfly trade.

The credit spread is a two legged trade – made up of a ‘short’ leg (sold leg) which is closer to the ATM position – and the other leg is a bought leg – purchased further away from both the ATM position and the sold leg.

The intent of the credit spread method is to short an option at a position on the chart where the one placing the trade feels the stock being used will not reach by expiration. If the trader chooses correctly, the premium that was initially delivered into the account is allowed to be kept and the returns can be impressive.

Here is an illustration of a bull put spread on IWM…

Sell 25 Puts at 65
Buy 25 Puts at 60

With this illustration, the above spread trade will be profitable as long as IWM remains higher than the 65 price while the trade is in play.

Vertical Spread

This website / blog is all about the option vertical spread – what it is, how it works, and how to trade this option strategy for consistent monthly income.