Options spreads are the basic building blocks of many
options trading strategies. A spread position is entered by buying and selling options of the same class on the same underlying security but with different
strike prices or expiration dates. An option spread shouldn't be confused with a
spread option. The three main classes of spreads are the horizontal spread, the vertical spread and the
diagonal spread. They are grouped by the relationships between the strike price and expiration dates of the options involved - •
Vertical spreads, or money spreads, are spreads involving options of the same underlying security, same expiration month, but at different strike prices. • Horizontal,
calendar spreads, or time spreads are created using options of the same underlying security, same strike prices but with different expiration dates. • Diagonal spreads are constructed using options of the same underlying security but different strike prices and expiration dates. They are called diagonal spreads because they are a combination of vertical and horizontal spreads. Any spread that is constructed using
calls can be referred to as a call spread, while a put spread is constructed using
puts.
Bull and bear spreads If a spread is designed to profit from a rise in the price of the underlying security, it is a
bull spread. A
bear spread is a spread where a favorable outcome is obtained when the price of the underlying security goes down.
Credit and debit spreads If the premiums of the options sold is higher than the premiums of the options purchased, then a net credit is received when entering the spread. If the opposite is true, then a debit is taken. Spreads that are entered on a debit are known as
debit spreads while those entered on a credit are known as
credit spreads.
Ratio spreads and backspreads There are also spreads in which unequal number of options are simultaneously purchased and written. When more options are written than purchased, it is a
ratio spread. When more options are purchased than written, it is a
backspread.
Spread combinations Many options strategies are built around spreads and combinations of spreads. For example, a
bull put spread is a bull spread that is also a credit spread; the
iron butterfly can be broken down into a combination of a
bull put spread and a
bear call spread; the
iron condor is a combination of a put spread and a call spread with the same expiration and four different strikes; and the
jelly roll is a long calendar spread and a short calendar spread at the same strike price.
Box spread A
box spread consists of a
bull call spread and a
bear put spread. The calls and puts are on the same
underlying and have the same
expiration date. The resulting portfolio is
delta neutral. For example, a 40-50 January 2010 box consists of: • Long a January 2010 40-strike call • Short a January 2010 50-strike call • Long a January 2010 50-strike put • Short a January 2010 40-strike put Barring early exercise on
American-style legs, a box spread position, constructed with
European-style options, has a constant payoff at exercise equal to the difference in strike values. Thus, at exercise, the 40-50 box example above pays +10 long or -10 short. For this reason, a box is sometimes considered a "pure interest rate play" because buying one basically constitutes lending some money to the counterparty until exercise. Box spreads can be used as a financing or cash management tool, as institutional market participants have for decades. However, improperly structured box spreads using
American options can expose investors to low-probability, extremely-high severity risk: if the options are exercised early, they can incur a loss much greater than the expected gain. To streamline execution and curb early-exercise risk, fintech firms have begun rolling out automated box-spread solutions, from financing platforms like
SyntheticFi to cash-management offerings from Alpha Architect. ==Option strategy profit / loss chart==