The Complete Guide to Option Strategies: Advanced and Basic Strategies on Stocks, ETFs, Indexes, and Stock Indexes

CHAPTER 6

Understanding Spread Terminology

What is in a name? If the question relates to options, the answer is—a lot. You should understand option terminology so you can effectively use your option trading platform (supplied by your broker) to become a better trader. Your trading platform should enable you to enter and exit simple and complex positions, such as spreads, with the click of a mouse. This chapter defines a spread from the perspective of buying versus selling, debit versus credit, and bull versus bear and provides examples of spreads. Spread strategies are covered extensively throughout this book.

WHAT IS A SPREAD?

A spread trade is the standard bread-and-butter type of trade of many professionals. In the business world, a spread can have a variety of meanings but generally refers to the difference between two (or more) prices from different sides, or legs, of a trade. For example, outside the world of options, a spread trade may involve buying the S&P 500 index and selling (shorting) the Russell 2000 index in an attempt to profit from large capitalization stocks outperforming small capitalization stocks. A spread trade may involve, for example, buying the 30-year bond and selling the 2-year note. Another type of spread is the bid/ask spread, which represents the difference in the price at which an instrument can be purchased versus bought, as determined by the marketplace.

An option spread is the purchase (or sale) of one option contract against the sale (or ...