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In the previous lesson, we understood the basic concept of the Covered Call Options Strategy and how to implement it in an app. Today, we will introduce the second common type of portfolio strategy - the Vertical Spread Strategy.
1. What is the Vertical Spread Strategy?
The Vertical Spread Strategy, in essence, involves simultaneously buying and selling options with the same expiration date but different strike prices. This allows you to lock in a profit range within a fixed interval. Why is it called "vertical"? Because the bought and sold options have different strike prices, and they appear vertically on an options chain.
For instance, suppose we're in the options chain for Apple with an expiration date of August 4th. We buy a call option with a strike price of $195 and simultaneously sell a call option with a strike price of $205. Here, the two strike prices are arranged vertically.
The Vertical Spread Strategy can be divided into four types based on the buy/sell direction and the use of call and put options: Bullish Call Spread, Bullish Put Spread, Bearish Call Spread, and Bearish Put Spread. The Bullish Call Spread and Bearish Put Spread are debit spreads while the Bullish Put Spread and Bearish Call Spread are credit spreads.
1.1 Bullish Call Spread
The Bullish Call Spread strategy involves buying a lower strike call option and simultaneously selling a higher strike call option.
This strategy is suitable when we anticipate a slight increase in a stock's future value. While gaining from the price rise by buying the call option, simultaneously selling a call option at a higher price achieves two things: it generates additional premium income, thereby increasing potential returns, and it partially offsets the time value decay that affects the purchased call option.
For example: Apple's current stock price is around $184. Assuming that after one month, on August 25th, the stock price has risen slightly to around $190, we can utilize the Bullish Call Spread strategy. First, we buy a call option with a strike price of $185, paying a premium of $0.94. At the same time, we sell a call option with a strike price of $190, receiving a premium income of $0.08.
If the future stock price indeed aligns with expectations and rises to $190, the call option with a strike price of $185 would yield a profit of $4.06 ($190 - $185 - $0.94), while the call option with a strike price of $190 wouldn't be exercised, resulting in a profit of $0.08 from the premium income. Ultimately, the entire strategy would yield a profit of $4.14. In other words, compared to simply buying a call option, this strategy increases returns by $0.08.
Of course, if the stock price doesn't move in the expected direction, what would our profits and losses look like? Let's assume the stock price decreases below $185. In this case, neither option would be exercised, and the maximum loss would be the net premium outlay of $0.86.
If the stock price increases to or above $190, the strategy would achieve its maximum profit of $4.14.
If the stock price ends up between $185 and $190, the strategy's profit/loss would range from -$0.86 to $4.14.
How to Implement the Bullish Call Spread Strategy Using an App?
It is straight forward to execute this strategy using the Tiger Trade app and even calculate the combined profit data directly through the app. How do we do it?
Continuing from the previous example, click on the strategy section below and select the Vertical Spread Strategy. Then, modify the default spread to 5 (the spread between the two options, $185 and $190, is 5). This will display all the option portfolios with a spread of 5. You can select the desired call option spread. After clicking, the app will automatically calculate the portfolio's maximum profit, maximum loss, and profit-loss curve data (considering contract units, all data in practical execution is theoretically multiplied by 100 (as there are 100 shares per option), and it includes transaction costs like fees, so there might be some deviation).
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Comments
The Vertical Spread Strategy can be divided into four types based on the buy/sell direction and the use of call and put options: Bullish Call Spread, Bullish Put Spread, Bearish Call Spread, and Bearish Put Spread.
Bullish traders will use bull call spreads and bull put spreads. For both strategies, the trader buys the option with the lower strike price and sells the options with the higher strike price. Aside from the difference in the option types, the main variation is in the timing of the cash flows. The bull call spread results in a net debit, while the bull put spread results in a net credit at the outset.
Bearish traders utilize bear call spreads or bear put spreads. For these strategies, the trader sells the option with the lower strike price and buys the option with the higher strike price. Here, the bear put spread results in a net debit, while the bear call spread results in a net credit to the trader's account.
垂直价差（Vertical Spread）分为以下四种：
牛市看涨价差（Bull Call Spread）
牛市看跌价差（Bull Put Spread）
熊市看涨价差（Bear Call Spread）
熊市看跌价差（Bear Put Spread）
实际上，四种方式分两个观点（看多、看空），同样的观点，可以用买卖看涨或者看跌期权表达，又分为两种，这样便诞生了4种垂直价差。
牛市看涨价差，Bullish Call Spread 是购买较低执行价的看涨期权，同时出售另一个到期日相同但执行价格较高的看涨期权（在同一标的资产上）。由于执行价低的看涨期权比较贵，所以支付的费用大于收到的费用，是一个借方价差，最大损失仅限于借方敞口（两个期权一买一卖的期权费价差），而最大利润等于看涨期权的执行价格减去借方敞口的差额。
As the above mentioned, “The Vertical Spread Strategy can be divided into four types based on the buy/sell direction and the use of call and put options: Bullish Call Spread, Bullish Put Spread, Bearish Call Spread, and Bearish Put Spread.”
A Bullish Call Spread is purchasing a call option, and simultaneously selling another call option (on the same underlying asset) with the same expiration date but a higher strike price. Since this is a debit spread, the maximum loss is restricted to the net premium paid for the position, while the maximum profit is equal to the difference in the strike prices of the calls less the net premium paid to put on the position.
A bull vertical spread profits when the underlying price rises; a bear vertical spread profits when it falls. As to which vertical spread to use depends on market conditions. Thanks loads @Tiger_Academy for this AWESOME post❣️Love the videos as they’re easier to understand❣️