Option Spread Trading
By: Ron Ianieri
We have demonstrated how well options function in unison with a
stock position. They enhance potential gains, provide profit
protection and limit the risk of the entire investment. They
enable us to manage risk in a single stock as well as an entire
portfolio. But, as good as options are in conjunction with
stocks, they can be even better when traded against each other.
Spreads are strategies that do not involve the use of any
security other than another option. Their positives are that
they are inexpensive, offer protection for both buyer and seller
and are in effect automatically hedged trades.
Spreads can provide large percentage returns with low risk and
can be entered into with small capital outlay. A spread involves
the purchase of one option in conjunction with the sale of
another option. There are many types of spreads. Some take
advantage of stock movements while others are set up to take
advantage of movements in implied volatility and even time
decay. There are calendar or time spreads, diagonal spreads,
ratio spreads and also vertical spreads, which we will discuss
in depth here.
Spreads are more advanced and sophisticated than the strategies
discussed in our beginner product OPTIONS 101. Where certain
spreads, like 1 to 1 vertical spreads, can be less risky than a
buy-write, there are more variables to consider and control
which makes trading the spread more complicated.
When you trade a spread you are dealing with three elements: the
spread as a whole (which you can buy or sell) and its component
parts the option you buy and the option you sell.
Although the cost of most spreads is relatively inexpensive to
initiate, they can provide a large percentage return and there
is protection (limits) to both sides of the trade. Therefore,
even experienced investors can profit from learning about
spreads and their investment potential.
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