Nick Katiforis

Option Spread Trading

Option Spread trading refers to a strategy whereby option traders trade two or more options with different exercise prices or contract months. It offers a way of reducing the cost to option buyers and can provide protection for option writers.

A common option buying spread trading strategy is a bull call spread (buy call, write higher call). Writing the higher strike call option reduces the cost of the bought call whilst still giving a good profit potential.

A common option writing spread strategy is the credit call spread (Write a call and buy a higher strike call). Buying the higher strike call caps the potential loss in case the market moves substantially against your position.

Of the three general strategies—trading futures, buying options or buying option spreads—buying option spreads has the lowest risk.

For example a typical futures contract can gain or lose USD$500—$1,000 in any day depending on the market traded. Option spreads in contrast typically move USD$50—$100 in any one day.

For futures traders, particularly those that have relatively small trading accounts, lowering risk is paramount. Option (debit) spreads require no margin and the downside risk is known and fixed beforehand. The maximum dollar amount that can be lost in a worst case scenario is the price initially paid for the position including brokerage.

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