Option spreads are created when we buy one option and simultaneously sell another option. When the two options are within the same expiration month, the spread is known as a vertical spread. The vertical spread derives its name from the early days of options trading when the prices were posted on a wall with the strike prices listed vertically and the different expiration months listed horizontally across the top. Spreads created by buying and selling options within the same expiration month, or from the same vertical column, were called vertical spreads.
Later in this book we will discuss calendar spreads, wherein one buys an option in a future month and sells the option in the front month at the same strike price. The older name for this spread is a horizontal spread due to the positions of the options on the board: both in the same row (same strike price) but in different columns (different expiration months).
Vertical spreads are useful tools for the trader to profit from her prediction of a stock’s price move. But it is also important to fully understand the intricacies of vertical spreads because they form the building blocks for more complex options strategies such as the condor and butterfly spreads.
BUILDING THE VERTICAL SPREAD
Let’s start with an example of a vertical spread. With IBM trading at $126, we buy an IBM $120 Feb call for $6.43 or $643 for one contract. I can then create a spread by selling the IBM $130 Feb call for $0.75 or $75. ...