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Education / Track IV · Strategy Construction / L.15

Vertical Spreads

A vertical spread is the cleanest expression of a directional view with bounded risk. It is the first multi-leg structure most traders learn, and it remains useful long after fancier structures have been tried and abandoned.

14 min read · Lesson 15 of 24

What a vertical spread is

A vertical spread is two options of the same type (both calls or both puts) on the same underlying with the same expiry, but at different strikes. One leg is long; the other is short. The structure is named "vertical" because the two strikes line up vertically on the same expiry on the options chain.

There are four basic vertical spreads, formed by combining call/put with bullish/bearish:

Bull call spread

$95 $105 0 +$10 −$10 Underlying Price at Expiry P&L per Contract Long $95 Short $105 BE $99 Bull Call Spread · Long $95 / Short $105 · Debit $4
Fig. 15.1 Bull call spread. Long $95 call, short $105 call, $4 net debit. Maximum profit at $105 or above. Maximum loss at $95 or below.

Suppose SPY is at $100. You think it will rise modestly over the next month. You buy the $95 call for $7 and sell the $105 call for $3. Net cost is $4. The position is bullish but capped on both sides.

If SPY closes above $105 at expiry, you make $6 (the $10 spread minus the $4 debit). If SPY closes below $95, both calls expire worthless and you lose the $4 debit. Your breakeven is $99 (the lower strike plus the debit).

Compared to buying the $95 call alone, you have given up unlimited upside in exchange for paying $3 less. If your view is "SPY will rise modestly," the spread is more capital-efficient. If your view is "SPY will rip," the naked call is better.

Bear put spread

$95 $105 0 +$10 −$10 Underlying Price at Expiry P&L per Contract Short $95 Long $105 BE $101 Bear Put Spread · Long $105 / Short $95 · Debit $4
Fig. 15.2 Bear put spread. Long $105 put, short $95 put, $4 net debit. Mirror image of the bull call spread.

Same idea, opposite direction. You buy the higher-strike put and sell the lower-strike put. Maximum profit when the underlying falls below the lower strike. Maximum loss when it rises above the higher strike. Used to express moderate bearish views.

Credit spreads (the other two)

The bear call spread and bull put spread are credit spreads. Instead of paying a debit and waiting for movement, you collect a credit and hope the underlying stays in or moves into the favorable range.

A bull put spread example: SPY at $100. Sell the $95 put for $2, buy the $90 put for $0.50. You collect $1.50 credit. If SPY stays above $95, both puts expire worthless and you keep the credit. Maximum loss is $3.50 (the $5 spread minus the $1.50 credit) if SPY closes at or below $90.

Credit spreads are the workhorse of short-premium strategies. They generate income when the underlying behaves as expected, with capped risk if it does not.

Debit vs credit framing
Debit spread: pay now, profit if a specific move happens. Credit spread: get paid now, profit if a specific move does not happen. Both are bounded-risk, but the former bets on movement and the latter bets on non-movement (or movement only in the favorable direction).

Why use spreads instead of single options

Three main reasons:

  1. Capital efficiency. The premium paid (or margin required) is much smaller than for the equivalent single option.
  2. Defined risk. Maximum loss is known up front. No surprises if the underlying moves violently.
  3. Reduced vega and theta. The long and short legs partially offset each other on the Greeks. The spread is less sensitive to IV changes than a single option.

The cost is upside cap. You give up the open-ended profit of a single long option in exchange for these benefits.

Width and ratios

The distance between the two strikes (the width) determines the maximum payoff and the maximum loss. A $5-wide spread on SPY can pay at most $5 ($500 per contract). A $20-wide spread can pay at most $20. Wider spreads pay more but cost more (or generate less credit) and have more capital at risk.

Asymmetric ratios (long 1 / short 2, etc.) turn vertical spreads into ratio spreads, which have very different risk profiles. They reintroduce the unbounded risk that the simple spread eliminated. Beginners should stick to one-to-one verticals until comfortable with the Greeks of the resulting position.

Strike selection by delta

Most experienced traders pick spread strikes by delta, not by dollar distance. A common credit spread uses the 30-delta short strike and the 15-delta long strike. This produces a spread with roughly 70% probability of finishing OTM (favorable) and a defined risk of the 15-delta strike's distance.

Choosing strikes this way scales across underlyings. A 30-delta credit spread on SPY and a 30-delta credit spread on AMZN have similar statistical profiles even though the absolute strikes are wildly different.

When to take profit and when to close

Vertical spreads have natural exit points. Many systematic traders close winning credit spreads at 50% of maximum profit. The remaining 50% takes much longer to capture and exposes the position to assignment risk near expiry. A 50% rule is mechanical, easy to follow, and historically improves risk-adjusted returns on credit-spread strategies.

For losing positions, closing at 1x or 2x credit received caps the damage. Letting losers run to expiry on hope of recovery is the most common way short-premium traders blow up small accounts.

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