Vertical Spread

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.