Vertical spreads
Option strategies involving two options of the same type (either two puts, or alternatively two calls).
"Vertical" refers to the options being of the same type and expiration date. The same number of underlying units are common to the two options in a vertical spread, and they are only differentiated by each option in the pair having a different strike.
Vertical spreads payouts are limited to the difference between the two strikes of the options.
Call spreads involve the simultaneous purchase of a call, and sale of a different strike call.
Put spreads involve the simultaneous purchase of a put, and sale of a different strike put.
Bull and bear spreads.
“Bull” and “bear” refer to the directional sensitivity of spreads and their payouts to the underlying.
Depending on the relative location of their two strikes, call spreads and put spreads may benefit from higher or lower underlying prices.
Positions benefiting from high underlying prices, are net long positions, and are said to be bullish.
Positions benefiting from low underlying prices, are net short positions, and are said to be bearish.
If no directional type of spread is identified, it is usually the case that a call spread means the purchase of a low strike call and sale of a higher strike call (a bull call spread) .
By the same token unidentified put spreads usually mean the purchase of a high strike put and sale of a lower strike put (a bear put spread).
In the money or out of the money.
Directional location of a spread versus the underlying is referred to as in the money, around the money or out of the money, and is determined by the type of options and their positioning versus the underlying.
Call Spreads with both of their strikes above the current price of the underlying are said to be out of the money. Put spreads with both of their strikes above the current price of the underlying are said to be in the money.
Call Spreads with both of their strikes below the current price of the underlying are said to be in the money. Put spreads with both of their strikes below the current price of the underlying are said to be out of the money.
Range of a Vertical Spread
The range of a spread is the absolute value of the difference between the high and the low strikes of the two spread options. It is indistinctive of the option types (calls or puts). It is also the high strike minus the low strike of a vertical spread.
The range of a vertical spread is also the maximum payout of a spread strategy.
It is useful to think about net premiums of spreads in percentage terms of the range. The net premium of a spread divided by the range is alike a cost implied probability of the payout.
Payout symmetry.
Option spreads with the same strikes exhibit two important payout characteristics.
For a given pair of ranges (same high strike and low strike), the sum of the payouts of a bull call spread and a bear put spread is equal to the value of the range. The same is true for the sum of equal strikes bear call and bull put spreads.
After factoring in the premium, a bull call spread has the same payout of a bull put spread. The same is true for the sum of equal strikes bear call and bear put spreads.
Credit and Debit.
Credits and debits refer to the net impact of transaction premiums to an account. For vertical spreads, one option is purchased, and another option is sold, the net cost of the strategy may be positive or negative.
From the perspective of an investor initiating a position, a spread with a positive net premium is said to be for debit. The account of the investor is debited when initiating the position.
From the perspective of an investor initiating a position, a spread with a negative net premium is said to be for credit. The account of the investor is credited when initiating the position.
The use of credit and debit terms to describe payouts may lead to inconsistencies as the buyer of a spread has the opposite position than its seller.
From the perspective of the investor, bull call spreads and bear put spreads are debit positions. Since the net premiums in the spreads are positive, establishing the spread generates a debit to the investor account.
From the perspective of the investor, bull put spreads and bear call spreads are credit positions. Since the net premiums are negative, establishing the spread generates a credit to the investor account.
Early Assignment - American options spreads.
American options are subject to early exercise. Since all vertical spreads involve a short option in one of their legs, the american feature implies that the short option could be exercised prior to expiration, without investor control.