Finance

Vertical Vs Credit Spreads in the UK: Your How-to Guide

Vertical Vs Credit Spreads in the UK

There are two main types of options trades—vertical spreads and credit spreads.

The option trader’s choice between these two depends on whether they think the underlying stock price will go up, stay flat, or fall.

The other factor that influences this decision is risk tolerance.

Vertical spreads are significantly lower-risk than credit spreads, as you’ll make money if the underlying stock stays flat or falls slightly (or doesn’t move much at all), rather than depending on it going up in value.

The article below will compare and contrast vertical vs credit spreads to help you decide which type of trade is right for your goals & trading style:

Vertical spreads

Let’s first take a look at vertical spreads.

What is a vertical spread?

It is an options strategy where the person doing options trading buys and sells different strike prices of the same type (all calls or puts) with the same expiration date.

You create a net cost or credit when opening the trade (hence ‘credit spread’) when you do this.

What is the difference between vertical spreads?

There are two types of vertical spreads: Calls & Puts.

The difference lies in whether you think the underlying stock price will go up/stay flat or fall: Vertical Call Spread: You buy an ‘in-the-money’ call and sell an ‘at-the-money’ call with the same expiration date.

Vertical Put Spread: You buy an ‘out-of-the money’ put and sell an ‘at-the-money’ put with the same expiration date.

Is there a risk difference between vertical spreads?

Yes, there is a considerable difference in risk between vertical spreads, as this will depend on how far out of the money your options are when you open the trade.

If you buy an ‘in-the-money’ option and sell an ‘out-of-the money’ option, then you will have limited risk (with no downside) and a net credit.

It means that if the price of the underlying stock doesn’t move at all, then you’ll keep your entire credit as profit.

However, if it goes up / down much more than expected (to break even), this trade could be worthless. – If you buy an ‘out-of-the money’ option and sell an ‘in-the-money’ option, then you will have unlimited risk (with no upside) and a net debit.

It means that if the underlying stock price doesn’t move at all, you’ll lose your entire cost as profit. However, if it goes up / down much more than expected (to break even), this trade could be worthless.

How Much Can I Make a Profit/Loss from Vertical Spreads?

When opening the trade, the maximum profit for vertical spreads is limited to the difference in strike prices minus the net debit/credit. -Vertical Call Spread: Maximum profit = Credit received – Strike A Price – Netdebit when opening the trade – Vertical Put Spread: Maximum profit = Strike B Price – Strike A Price – Net debit when opening the trade.

Credit Spreads

Now that you have vertical spreads down let’s look at credit spreads.

What is a credit spread?

A credit spread is where you open two options (same expiration date) at different strike prices (with both options having the same underlying asset and type).

If one of your options costs more than the other (i.e. if you opened a put credit spread or call credit spread), then you will have used a net debit to open the trade (hence ‘credit spread’).

What is the difference between credit spreads?

There are two types of credit spreads; Calls & Puts. The contrast lies in whether you think the underlying stock price will go up/stay flat or fall – Call Credit Spread.

You buy an ‘in-the-money’ call and sell an ‘out-of-the-money call with the same expiration date – Put Credit Spread: You buy an ‘out-of-the money’ put and sell an ‘in-the-money’ put with the same expiration date.

Is there a risk difference between vertical spreads?

Yes, there is a considerable difference in risk between vertical spreads, as this will depend on how far out of the money your options are when you open the trade. If you buy an ‘in-the-money’ option and sell an ‘out-of-the money’ option, then you will have limited risk (with no downside) and a net credit. It means that if the price of the underlying stock doesn’t move at all, then you’ll keep your entire credit as profit.

You can visit our website for more information about trading terms such as ETFs, CFDs, Trends, and many more.

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