What are vertical spreads in options trading?

What’s on this page?

1. What is a vertical spread?
2. How do vertical spreads work?
3. Types of vertical spreads
4. Examples of vertical spreads
5. Key considerations for vertical spreads

What is a vertical spread?

A vertical spread is an options trading strategy that involves simultaneously opening long (buying) and short (selling) positions on the same underlying asset (the stock or other security the option is based on) with identical expiration dates but different strike prices (the price at which the option can be exercised or assigned). This directional strategy uses either put or call contracts for both positions.

The term ‘vertical’ is a reference to how the strike prices are positioned – one lower and the other higher, in the same expiration cycle. This is different to other spread types, such as calendar spreads, where the expiration dates differ.

How do vertical spreads work?

Vertical spreads enable you to speculate on market direction while defining both maximum profit and loss at the outset. The strategy involves taking offsetting positions, which – depending on the setup – results in either a credit or debit spread.

In a debit spread, the maximum loss is known at entry, so these positions are typically not actively managed. Credit spreads, however, may require management in certain situations to help control potential losses.

Calculating breakeven points

Knowing how to calculate breakeven points is crucial for assessing the potential profitability of a vertical spread:

• Long call spread: long call strike + net debit paid
• Short call spread: short call strike + net credit received
• Long put spread: long put strike - net debit paid
• Short put spread: short put strike - net credit received

The role of implied volatility

Implied volatility (IV) is a measure of how much the market expects an underlying’s price to change. It affects options prices:

• When IV is high, options prices are higher. Traders often sell options (credit spreads) to try benefit from potentially falling prices
• When IV is low, options prices are lower. Traders might buy options (debit spreads) as they're cheaper and could increase in value if market uncertainty grows

The implied volatility environment plays a crucial role in selecting the appropriate vertical spread strategy:

Credit vs debit spreads

Vertical spreads are classified based on whether you receive or pay money when you open the trade:

• Credit spreads: you get money (credit) when you open the trade. You profit if the spread's value decreases
• Debit spreads: you pay money (debit) when you open the trade. You profit if the spread's value increases

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Types of vertical spreads

There are four main types of vertical spreads:

1. Long call spread (bullish)
2. Short call spread (bearish)
3. Long put spread (bearish)
4. Short put spread (bullish)

Each type has unique characteristics in terms of profit potential, maximum loss and ideal market conditions.

Long call spread (bullish)

This strategy involves buying a call option and selling a higher strike call option in the same expiration cycle. It can be used when you expect a moderate rise in the underlying asset's price.

Short call spread (bearish)

In this strategy, you’ll sell a call option and buy a higher strike call option in the same expiration cycle. It can be used when you’re expecting a decline or stability in the underlying asset's price.

Long put spread (bearish)

This involves buying a put option and selling a lower strike put option in the same expiration cycle. It can be used when you’re expecting a moderate decline in the underlying asset's price.

Short put spread (bullish)

Here, you'll sell a put option and buy a lower strike put option in the same expiration cycle. It can be used when you’re expecting an increase or stability in the underlying asset's price.

Key considerations for vertical spreads

• Risk management: while vertical spreads have defined risk, proper management can help optimise outcomes
• Expiration handling: it's usually best to close your trade before the options expire to avoid complications
• Rolling: this means closing your current trade and opening a similar one with a later expiration date or different strike prices
• Legging out: this means closing one part of your spread while keeping the other open. It's risky and can change your potential profit or loss dramatically

You can trade vertical spreads in listed options on our US options and futures platform.