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Essential Option Strategies by J. Kinahan

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Chapter 13Short Vertical Spreads

Short vertical spreads are the exact opposite of the strategies covered in the previous chapter. I noted in Chapter 12 that a long vertical call spread involves buying a call with one strike and selling another at a higher strike. The investor pays a debit for the long vertical call spread, and the risk is limited to the debit paid. The position offers a maximum payout if the underlying security rises in price and stays above the higher strike of the spread through the expiration. Therefore, the long vertical call spread is typically initiated when the investor has a bullish outlook and expects the price of the underlying security to move higher.

The short vertical call spread is the reverse of the long vertical call spread. The investor is selling a call and buying a call with a higher strike. The trade is initiated at a credit, and the premium collected is the maximum potential profit from the strategy. The risk is also limited, because the call with the higher strike is hedging the risk of the short call with the lower strike. The strategy is typically a bearish play on the underlying security. However, the short vertical call spread, often using out-of-the-money (OTM) calls to take advantage of time decay, can be initiated if the investor expects stock price to hold in a range as well. The ideal scenario is for the underlying to finish below the lower strike of the call spread at expiration and for the options to expire with no intrinsic ...

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