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NEW YORK (
Options Trading Signals
) -- Let's discuss an options strategy that often is overlooked.
Besides covered calls and cash-secured naked puts (which have the same risk profile, by the way), one of the most basic spread constructions available to option traders is the vertical spread.
A vertical spread can be written when an option trader believes prices are going up (bull call spread) or when prices are going down (bear put spread).
In addition to those debit trades, option traders also have the ability to place vertical credit spreads.
All types of vertical spreads are a very basic option trading strategy, but they can produce strong returns with defined risk.
A brief description of a vertical debit spread involves buying a call or put and simultaneously selling a strike farther away from the money.
Vertical debit spreads always have a directional bias depending on whether calls or puts or used.
The sale of the call or put that is further away from the money results in a credit and helps reduce the total cost of the spread, thereby reducing the capital risk.
A call debit spread, also called a bull call spread, is used when a trader expects higher prices. A put debit spread, also called a bear put spread, is utilized when the option trader expects lower prices.
A vertical credit spread is established in the opposite manner. The construction involves selling a call or put that is closer to the money and buying a strike that is farther away from the money.
This strategy profits from time decay as well as price action. The maximum gain is limited to the difference in the credit received for the contract that is sold and the debited premium that is required to purchase the long strike.
Vertical credit spreads always result in a trader receiving a credit. A call credit spread, also known as a bear call spread, is used when an options trader is expecting lower prices. A put credit spread, also known as a bull put spread, is utilized when an options trader expects higher prices.