8
Call spreads and put spreads,
or one by one directional
spreads
Investors with a directional outlook often find the risks of a straight long
or short options position to be undesirable. A stock index may be at a his-
torically high level, and therefore an investor may want to sell calls or
buy puts in order to profit from a decline. But per-
haps the market is still too strong to sell ‘naked’
calls, i.e. short calls without a hedge. If premium
levels are high, then the investor may not want
to risk investing in a straight put purchase. A sen-
sible alternative is to spread the risk of a straight
options position by taking the opposite long or
short position at a strike price that is more distant
from the underlying.
For example, if XYZ is trading at 100, we may buy the 95 put and simul-
taneously sell the 90 put, thereby creating a long put spread, a bearish
strategy. If instead we are bullish, we may sell the 95 put and buy the 90
put, creating a short put spread.
Another bullish strategy is to buy the 105 call while selling the 110 call,
creating a long call spread. If instead we sell the 105 call while buying
the 110 call, we create a short call spread, an alternative bearish strategy.
These four spreads are also known as vertical spreads.
Spread the risk of a
straight options position
by taking the opposite
long or short position
at a strike price that
is more distant from
the underlying
74 Part 2
Options spreads
In practice, both strikes of the call or put spread are usually placed out-of-
the-money. The key to all these spreads is the option that is at, or nearest
to, the underlying. We will discuss each of them.
In addition, by spreading one option against the other, you are also
spreading cost against cost, so if one option is dear, then it is financed
by another that is dear. You also minimise your exposure to the Greeks. I
repeat: you minimise your exposure to the Greeks.
The profit/loss calculations that form the basis of these spreads can be
applied to any underlying in stocks, bonds, commodities or FX. For the pur-
pose of illustration, a set of options on a stock index is given in Table 8.1:
SPDR at 115.22
45 days until June expiration
Contract multiplier of $100
Table 8.1 SPY options
Strike
107 109 111 113 115 117 119 121 123
June calls
5.05 3.80 2.60 1.70 1.00 0.55
June puts
1.75 2.15 2.60 3.10 3.90 4.80
*Long call spread
Bullish strategy
The SPDR
1
(‘Spider’) is currently trading at 115.22. You may wish to pur-
chase the 117 call to profit from an upside move. It’s close to expiration,
time decay is costly, and the implied volatility is higher than it has been
recently, so an expenditure of 2.60 × $100, or $260 may seem too great.
You could sell the 119 call for 1.70 at the same time as you buy the 117
call, for a total debit of 0.90 or $90. Your short call then effectively finances
the purchase of your long call, and minimises your exposure to the Greeks.
1
S&P 500 ETF Trust. The options trade at Chicago’s CBOE. The SPDR is a mutual fund
based on the S&P 500. Just think of it as the S&P 500. The current open interest on this
options contract is a massive 13 million. In other words, everybody and his uncle trade
it. Because it’s 1/10th the size of the Spu’s, it’s affordable.

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