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Option spreads

Futures can be spread in many different ways, and options can be spread in even more. Only with options can you spread two different contracts of the same month. Option spreads can be constructed in a variety of ways to fine tune market outlooks. Although I rarely spread options, some of these strategies are very popular, and they fit in nicely with some trading styles.

Vertical call spreads

A vertical call spread is where you have two options of the same month but with different strike prices that are spread against each other. The vertical call spread is bullish, and the vertical put spread is bearish. For example, you're bullish wheat, it's March, and May wheat is trading at $4.20. You buy the May 420 call, pay 22¢, simultaneously sell the May 450 call, and take in 7¢. Your cost (excluding commissions) is the difference between the two premiums–in this case 15¢, or $750. The difference (always a debit) is your maximum risk. If the market at expiration closes below 420, you lose the 22¢ and keep the 7¢, a maximum risk of 15. Your maximum profit is the difference between the strike prices minus the debit. In this case, 450–420=30 and 30–15=15. At expiration, above 450 you lose penny for penny on the 450 what you make on the 420. So your maximum profit is at or above 450. Returning 30 for your 22 investment is the lower-priced call, but you keep the 7¢ for a total of 15¢.


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