The Basic Option Spreads That All Investors Should Know

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When an investor has securities in his or her portfolio, a strategy that he or she can pursue is “options spreading”.

Options spreading entails buying and selling options concurrently or buying various combinations of options. One of the simplest options spread is a long call.

Such an option is beneficial to the investor if the price of the underlying security increases. If the investor simultaneously purchases a put option at the same time as a long call, he or she has created a straddle, where the investment is profitable if the price fluctuates favorably or unfavorably, but fails if the price remains relatively constant.

A bull vertical spread exists when an investor buys a call option and simultaneously sells a call option with a higher strike price.

A bull vertical becomes profitable if the underlying asset increases in price. A butterfly describes a special case when three, equally spaced, similar type options have the same expiration. In a long butterfly, the three options must be bought and sold in a ratio of 1:2:1, otherwise a butterfly does not hold.

Combining trades with options spreads can open the doors to more complex strategies, such as the collar, fence, and risk reversal.

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