Vertical Spreads: Choosing the Width and the Strikes

Buy the 100 call, sell the 105 call, same expiration, net debit $2.00. That is a bull call spread, and before you send it you can already write down the most it can make, the most it can lose and the price where it breaks even. Two numbers produce all of that. One is the strike gap, the other is the price. The width sets how big the outcomes are. The strikes set the odds.

What the width decides

A vertical is two calls or two puts. Same expiration, different strikes. You own one and you are short the other. At expiration the spread can never be worth more than the gap between the strikes, because above the higher strike every extra dollar the long call gains is a dollar the short call loses.

So the width is a ceiling. On a 100/105 call spread the ceiling is $5.00 a share. Whatever you pay comes out of that ceiling.

Say the stock closes at $99 on expiration day. Both calls die and the $200 is gone. At $110 the long call is worth $10, the short call costs you $5, and the spread is worth its full $5.00, which leaves $300 of profit after the debit.

What happens when you widen it

Now move the short strike out to 110. The long call is unchanged, and the call you sell is further out of the money, so it brings in less and the spread costs more.

Everything got bigger. The best case more than doubled, from $300 to $650, while the worst case went from $200 to $350, and the break-even moved $1.50 further away from a stock that sits at $100 today. You bought more upside. The bill came as more money at risk and a longer walk to break-even.

Neither spread is better. The right width is the one whose maximum loss fits your risk per trade. With a $200 limit on one idea, only the 100/105 fits.

What the strikes decide

Keep the width at $5 and slide both strikes up. A 105/110 call spread on the same $100 stock might cost $1.20.

The payoff ratio looks far better: risk $1.20 to make $3.80. It is cheap for a reason. The stock has to rise more than 6% before the trade makes a cent, and a stock that sits still, drifts up a little or falls leaves you with the full $1.20 loss at expiration. That is the trade-off every vertical carries. Cheap spreads with big payoff ratios are cheap because they usually lose.

The delta column on the chain gives a rough sense of the odds. Very loosely, a short strike with a delta near 0.30 finishes in the money about three times in ten. Treat it as an estimate, never a promise.

Debit and credit versions

Every vertical comes in a debit form and a credit form. The debit version buys the option closer to the money and sells the one further away, while the credit version does the reverse, so you collect cash up front and want the options you sold to expire worthless or close to it.

A bullish credit vertical uses puts. Sell the 105 put, buy the 100 put, and suppose you collect $3.00. The most you keep is the $3.00. The most you lose is the width less the credit, 5.00 − 3.00, or $2.00. Same shape as the $2.00 bull call spread. Up $300, down $200, even at $102. With the same strikes and the same expiration, the debit call spread and the credit put spread are close to the same bet, and the price difference between them is usually small enough that the choice comes down to fill quality and which options you would rather see expire.

The bearish credit spread uses calls. Sell the 100 call and buy the 105 for a $2.00 credit, and the worst case is $3.00. Credit spreads also carry early assignment risk on the short leg, since holders of US equity options may exercise early, a point the lesson on managing a spread comes back to. Choosing strikes for a credit spread covers the credit side. The options hub has the rest.

Verticals only use one expiration. The next lesson, on time spreads, splits the legs across two dates and trades a different thing entirely: the speed at which near-term options lose value.