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Your Options Handbook: The Practical Reference and Strategy Guide to Trading Options by Jared A. Levy

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Chapter 7

Strategy: The Basic Spread Trades

Now let’s focus on some of the traditional, basic option spread strategies.

When you combine multiple types and strikes of options and/or buy and sell them against one another as a combination (or spread), the characteristics of those single options change, giving the spread a personality that may be completely different from what you are used to if you only were to trade individual options.

Vertical spreads in particular are not only simple to apply and analyze, but they can either increase your probability of success in a trade and they can also greatly reduce your risk if you are making a “directional” trade, but reducing costs.

In every instance, a vertical spread has limited risk and limited reward. Even though the rewards are limited, they can sometimes be 100% or more return on the amount at risk, so “limited” doesn’t necessarily mean mediocre.

VERTICAL SPREADS IN DEPTH

To help visualize the goal of the spread, sometimes it is best to think about the options at expiration and what they will be worth at that time to understand how your spread will eventually end up—this is called parity (no time value).

Obviously, to ignore or not understand the behaviors of that spread while you are in the trade is extremely foolish, as some spreads can completely change their behaviors depending on where their spread (strikes) lie in relation to the stock price. Vertical spreads are typically the first types of spreads that traders explore. Vertical ...

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