Strategy thinking
Vertical spreads: training wheels with teeth
The first multi-leg trade most pros teach. Defined risk, defined reward, defined direction. Three knobs, no surprises.
If I could only teach one options structure to a beginner, it would be the vertical spread. It is the cleanest container in the entire toolkit. Two legs, one expiration, one decision. Once you understand how a vertical works, every other multi-leg trade is just verticals glued together.
The four flavours
- Bull put spread: sell a put, buy a lower put. Bullish for credit. You profit if the stock stays above the short put.
- Bear call spread: sell a call, buy a higher call. Bearish for credit. You profit if the stock stays below the short call.
- Bull call spread: buy a call, sell a higher call. Bullish for debit. Pays out if the stock rallies.
- Bear put spread: buy a put, sell a lower put. Bearish for debit. Pays out if the stock drops.
Credit vs debit
Credit verticals collect premium up front. Their max profit is the credit, their max loss is the spread width minus the credit. They win on time decay and on the stock cooperating.
Debit verticals pay premium up front. Their max profit is the spread width minus the debit, their max loss is the debit. They need a directional move to pay out.
For most income-style trading, credit verticals are the workhorse. For convexity bets and earnings hedges, debits earn their keep.
How to size the strikes
I usually pick the short leg at 0.20 to 0.30 for credit verticals. That puts the strike outside one standard deviation of the expected move. The long leg goes one standard width further out, just enough to cap the risk without crushing the credit.
If you cannot collect a third of the width, the trade is too far out of the money. Walk closer or walk away.
What to do next
Open the scanner. Find a setup tagged broken wing butterfly or jade lizard. Read its legs and you will see verticals inside. The whole toolkit is verticals stacked on verticals.