Option Spreads:  What are they?



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What are option spreads and how do they affect your option trading?  This article seeks to answer that question and to also raise a few additional points that may be of interest.

Option spreading is the action of buying and selling options for the same underlying security at the same time.  If you buy a call (long option) and put option (short option) with the same expiration and strike price at the same time, then you've created a straddle.  This is a strategy that benefits greatly if the underlying security either goes up significantly or down.  If it doesn't move at all, you will likely lose your entire investment.

Another similar thing you can do is to buy a call and a put with an even lower strike. This is called a strangle. This option is cheaper, but requires larger moves in the price in order to benefit.

Other Option Spread Stragies

Another similar thing you can do is to buy a call and a put with an even lower strike. This is called a strangle. This option is cheaper, but requires larger moves in the price in order to benefit. A bull call spread is made by buying a call and selling a call with the same expiration but at a higher strike price. If the underlying security increases in price, you will make money. But the upside is diminished. The benefit of this is that you will spend less on the call you purchased due to the proceeds of the call you sold. The same can be done with puts. The butterfly spread involves buying 1 call, selling 2 calls at the strike price above the first call, and finally buying 1 more call above that. The ratio is 1:2:1 be considered a butterfly. This strategy benefits from a market that is largely inactive.