Options – What is a Vertical Spread?

What is a Vertical?

A vertical spread is a defined risk trade that takes up less capital than a naked option.

Components: A vertical is when you buy a option and sell a option in the same cycle / expiration date and of the same type.

Example: Sell the $24 put and buy the $23 put  in the same 43 day until expiration cycle. This limits your exposure to the width of the strikes minus the credit received. See the image below..

veritcal example in options

In this example your risking $100 – $31 in credit so Total risk: $69
Buying power reduced is equal to the total risk. You can see the platform is showing a Percentage Of Profit being 70% – this means there is a 70% chance of making a profit.

Break even: You can calculate the break even by taking the strike you sold, in this case the 21 put and subtracting your credit received .31. The break even on this vertical would be $20.69 – in case you were wondering the current stock price is $25.53

You can take the difference between the current price 25.53 – break even 20.69 to get $4.84 – Take that and divide by the current price to get a % move needed to breach the break even.  In this case it’s 19% move, a decently safe bet thus 70% POP (percentage of profitability).

Note: You can open this position and see a negative change in the value even if your break even hasn’t been reached – if the price goes against your position.. however you haven’t lost money until you either have to buy it back for more than you sold it for (max loss of .69) or get assigned (try to avoid this).