SPREADS

Before We start !!!!!!!!!!!!

What are Option

Spreads???????????????
In options trading, an option spread is created
by the simultaneous purchase and sale
of options of the same class on the same

underlying security but with different strike

prices and/or expiration dates.
Any spread that is constructed using calls
can be referred to as a call spread.

VERTICLE SPREADS
The vertical spread is anoption spreadstrategy
whereby the option trader purchases a certain
number of options and simultaneously sell an equal
number of options of the sameclass,
sameunderlying security, sameexpiration date, but
at a differentstrike price.
Vertical spreads limit the risk involved in the options
trade but at the same time they reduce the profit
potential.
They can be created with either allcallsor allputs,
and can be bullish or bearish.

Bull Vertical Spreads

Bull vertical spreads are employed when the option trader
is bullish on the underlying security and hence, they are
designed to profit from a rise in the price of the
underlying asset.
They can be constructed using calls or puts and are
known asbull call spreadandbull put spread
respectively.
While they have similar risk/reward profiles, the bull call
spread is entered on a debit while the bull put spread can
be established on a credit.
Hence, the bull call spread is also called a verticaldebit
spreadwhile the bull put spread is sometimes referred to
as a verticalcredit spread.

BEAR VERTICAL SPREADS

Vertical spread option strategies are also available for
the option trader who is bearish on the underlying
security. Bear vertical spreads are designed to profit
from a drop in the price of the underlying asset. They
can be constructed using calls or puts and are known
asbear call spreadandbear put spreadrespectively.
While they have similar risk/reward profiles, the bear
call spread is entered on a credit while the bear put
spread can be established on a debit. Hence, the bear
call spread is also called a verticalcredit spreadwhile
the bear put spread is sometimes referred to as a
verticaldebit spread.

Bull PUT Spread

The bull put spread option trading strategy is employed when
the options trader thinks that the price of the underlying asset
will go up moderately in the near term. The bull put spread
options strategy is also known as the bull put credit spread as
a credit is received upon entering the trade.
Bull Put Spread
Construction
Buy 1 OTM Put
ITM Put
Bull put spreads can Sell
be1implemented
by selling a higher
strikingin-the-money put optionand buying a lower
strikingout-of-the-money put optionon the same underlying
stockwith the sameexpiration date.

Limited Upside Profit

If the stock price closes above the higher strike price on
expiration date, both options expire worthless and the
bull put spread option strategy earns the maximum profit
which is equal to the credit taken in when entering the
position.
The formula for calculating maximum profit is given below:
Max Profit = Net Premium Received - Commissions
Paid
Max Profit Achieved When Price of Underlying >=
Strike Price of Short Put

Limited Downside Risk

If the stock price drops below the lower strike price on
expiration date, then the bull put spread strategy incurs a
maximum loss equal to the difference between the strike
prices of the two puts minus the net credit received when
putting on the trade.
The formula for calculating maximum loss is given below:
Max Loss = Strike Price of Short Put - Strike Price of
Long Put Net Premium Received + Commissions Paid
Max Loss Occurs When Price of Underlying <= Strike
Price of Long Put

Breakeven Point(s)
The underlier price at which break-even is achieved for
the bull put spread position can be calculated using the
following formula.

Bull Put Spread Example

Hassan Mujtaba believes that CIIT stock trading at $53 is
going to rally soon and enters a bull put spread by buying
a JULY Put options with strike price of 55 premium 2.50 per
share and spent $100 and writing a JULY Puts with strike
price of 57 and earned premium of 120. Thus, the trader
receives a net credit of $20 when entering the spread
position.
Scenario A
The stock price of CIIT begins to rise and closes at $60 on
expiration date. Both options expire worthless and the
options trader keeps the entire credit of $20 as profit,
which is also the maximum profit possible.

Bull Put Spread Example

Cont.
Scenario B
If the price of CIIT had declined to $48 instead, both options
expire in-the-money.
Hassan would buy the share from market at 48 and sell at
55, because he had bought put option. So he will earn (55-48)
$7,but after paying premium of $2.50 he is left with $4.50.
losses in the written puts = 48-57= -9, but after premium he
is left with -9+3= -6.
over loss would be: profit on put purchased $4.50, loss on
puts written -6 total (-6+4.50)= -1.50. (40 X 1.50= 60)
Total loss of $60 is the maximum loss Hassan bears.

Bear Put Spread

The bear put spread option trading strategy is
employed when the options trader thinks that the
price of the underlying asset will go down
moderately in the near term.
Bear put spreads can be implemented by buying
a higher strikingin-the-money put optionand
selling a lower strikingout-of-the-money put
optionof the same underlying security with the
sameexpiration date.

Construction

By shorting the out-of-the-money put, the options trader

reduces the cost of establishing the bearish position but
forgoes the chance of making a large profit in the event
that the underlying asset price plummets.
The bear put spread options strategy is also know as the
bear put debit spread as a debit is taken upon entering the
trade.

Bear Put Spread Payoff Diagram

Limited Downside Profit

To reach maximum profit, the stock price need to close below
thestrike priceof the out-of-the-money puts on the expiration date.
Both options expire in the money but the higher strike put that was
purchased will have higher intrinsic valuethan the lower strike put
that was sold. Thus, maximum profit for the bear put spread option
strategy is equal to the difference in strike price minus the debit
taken when the position was entered.
The formula for calculating maximum profit is given below:
Max Profit = Strike Price of Long Put - Strike Price of Short
Put - Net Premium Paid - Commissions Paid
Max Profit Achieved When Price of Underlying <= Strike
Price of Short Put

Limited Upside Risk & Breakeven

Point(s)
If the stock price rise above the in-the-money put option strike price at
the expiration date, then the bear put spread strategy suffers a
maximum loss equal to the debit taken when putting on the trade.
The formula for calculating maximum loss is given below:
Max Loss = Net Premium Paid + Commissions Paid
Max Loss Occurs When Price of Underlying >= Strike Price of
Long Put
Breakeven Point(s)
The underlier price at which break-even is achieved for the bear put
spread position can be calculated using the following formula.
Breakeven Point = Strike Price of Long Put - Net Premium Paid

Bear Put Spread Example

Suppose CIIT stock is trading at $38 in June. An Hassan Murtaza
bearish on CIIT decides to enter a bear put spread position by
buying a JUL 40 put for $300 and sell a JUL 35 put for $100 at the
same time, resulting in a net debit of $200 for entering this
position.
Scenario A
The price of CIIT stock subsequently drops to $34 at expiration.
Both puts expire in-the-money with the JUL 40 call bought having
$600 in intrinsic value and the JUL 35 call sold having $100 in
intrinsic value.
The spread would then have a net value of $5 (the difference in
strike price). Deducting the debit taken when he placed the trade,
his net profit is $300. This is also his maximum possible profit.

Bear Put Spread Example

Contin.
Scenario B
If the stock had rallied to $42 instead, both options
expire worthless, and the options trader loses the entire
debit of $200 taken to enter the trade. This is also the
maximum possible loss.

Bull Call Spread

The bull call spread option trading strategy is employed
when the options trader thinks that the price of the
underlying asset will go up moderately in the near term.
Bull call spreads can be implemented by buying anatthe-moneycall option while simultaneously writing a
higher strikingout-of-the-money call optionof the same
underlying securityand the sameexpirationmonth.

CONSTRUCTION
Bull Call Spread
Construction
Buy 1 ITM Call
Sell 1 OTM Call

By shorting the out-of-the-money call, the options trader

reduces the cost of establishing the bullish position but
forgoes the chance of making a large profit in the event that
the underlying asset price skyrockets.
The bull call spread option strategy is also known as the bull
call debit spread as a debit is taken upon entering the trade.

Bull Call Spread Payoff Diagram

Limited Upside profits

Maximum gain is reached for the bull call spread options
strategy when the stock price move above the higher strike
price of the two calls and it is equal to the difference
between the strike price of the two call options minus the
initial debit taken to enter the position.
The formula for calculating maximum profit is given below:
Max Profit = Strike Price of Short Call - Strike Price of
Long Call - Net Premium Paid - Commissions Paid
Max Profit Achieved When Price of Underlying >=
Strike Price of Short Call

Limited Downside risk &Break

Evenen Points
The bull call spread strategy will result in a loss if the stock price
declines at expiration.
Maximum loss cannot be more than the initial debit taken to enter
the spread position.
The formula for calculating maximum loss is given below:
Max Loss = Net Premium Paid + Commissions Paid
Max Loss Occurs When Price of Underlying <= Strike Price
of Long Call
Breakeven Point(s)
The underlier price at which break-even is achieved for the bull
call spread position can be calculated using the following formula.
Breakeven Point = Strike Price of Long Call + Net Premium
Paid

Bull Call Spread Example

An Hassan Nasir believes that ENGRO Foods stock trading at $42
is going to rally soon and enters a bull call spread by buying a
JUL 40 call for $300 and writing a JUL 45 call for $100. The net
investment required to put on the spread is a debit of $200.
Scenario A
The stock price of ENGRO Foods begins to rise and closes at $46
on expiration date.
Both options expire in-the-money with the JUL 40 call having
anintrinsic valueof $600 and the JUL 45 call having an intrinsic
value of $100.
This means that the spread is now worth $500 at expiration.
Since the trader had a debit of $200 when he bought the
spread, his net profit is $300.

Bull Call Spread Example

Contin..
Scenario B
If the price of CIIT had declined to $38 instead, both
options expire worthless.
The trader will lose his entire investment of $200, which
is also his maximum possible loss.

Aggressive Bull Call Spread

One can enter a more aggressive bull spread position by
widening the difference between the strike price of the
two call options.
However, this will also mean that the stock price must
move upwards by a greater degree for the trader to
realize the maximum profit.