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​Spread Strategies

 

Bull Call Spread

  • Involves purchase of Call options at a particular strike price and selling Call options for the same underlying and carrying the same maturity but having a higher strike price.
    • A vertical spread
  • Motivation
    • Downside protection by agreeing to a limit to the upside profits
  • Expectation
    • Moderate rise in the price of the underlying
  • Profit Potential
    • Maximum Profits when the trader is able to exercise the option purchased, i.e. the spot price is greater than the strike price of the option written
      • Difference in Strike Prices + Premium Received – Premium Paid
    • Loss is limited to:
      • Premium Paid – Premium Received, when the options expire unexercise

Bull Call Spread


 

Bear Spread

  • Involves purchase of put options at a particular strike price and the sale of the same put options at a lower strike price.
    • A vertical spread
  • Motivation
    • Downside protection by agreeing to a limit to the upside profits
  • Expectation
    • Moderate fall in the price of the underlying
  • Profit Potential
    • Maximum Profits when the trader is able to exercise the option purchased, i.e. the spot price is lower than the strike price of the option written
      • Difference in Strike Prices + Premium Received – Premium Paid
    • Loss is limited to:
      •  Premium Paid – Premium Received, when the options expire unexercised

Butterfly Spread

  • Involves sale and purchase of two calls (or puts) of the same underlying carrying the same maturity. A Long Call Butterfly can be established by selling two at the money calls with strike price say P, buying one out of money call at price say P+X and buying another in the money call at price say P-X
  • Motivation
  • To profit even when the price of the underlying is range bound and limit losses in case it moves beyond the expected bound
  • Expectation
  • Not much change in the price of the underlying
  • Profit Potential
  • Profits translate when the stock price remains within the bounds indicated by the purchased calls. Profits are maximized when the price of the underlying remains unchanged
    • Loss is limited to:
      •  Premium Paid – Premium Received, when the options expire unexercised

Butterfly Spread

 





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