Spreads
Buying one option and selling another at the same time. Cheaper, capped both ways, and the point at which options stop being simple.
Everything so far has involved one contract at a time. A spread means holding two or more together, deliberately, so that their behaviour partly cancels.
The simplest example
Buy a call with a $110 strike and sell a call with a $120 strike, same expiry, same share.
- You pay for the first and receive something for the second, so the position costs less than the call alone.
- Above $120, every extra dollar you gain on the bought call is lost on the sold one. Your gain stops there.
- Below $110, both expire worthless and you lose what the pair cost you.
A plain call profits more the further the share rises. This spread profits between $110 and $120 and then stops caring. You have paid less in exchange for giving away everything beyond a point you chose.
Debit and credit
- Debit spread. The option you buy costs more than the one you sell, so you pay to open it. Maximum loss is what you paid.
- Credit spread. The option you sell is worth more, so you receive cash. Maximum loss is the gap between the strikes, less what you received.
Why people use them
- Defined risk. Both the best and worst outcomes are known before you open the position.
- Lower cost. Selling one contract funds part of the other.
- Less exposure to volatility. The two contracts are affected similarly, so some of the vega cancels.
The costs nobody mentions first
Two contracts means paying the bid-ask spread twice on the way in and twice on the way out. On small positions these frictions can consume a meaningful share of the maximum possible gain before the market has done anything at all.
There is also leg risk: if you close one side and not the other, you are briefly holding a completely different position from the one you intended, sometimes an unlimited-loss one.
Where this goes next
Spreads are the doorway to a large family of structures with names like condors and butterflies. They are combinations of the same four basic positions, arranged to profit from particular ranges or from volatility rather than direction. The mechanics are not the hard part; sizing and execution are.