Vertical Spreads: Bull and Bear, Debit and Credit

EDUCATION, NOT ADVICE · Options can lose all of their value quickly. The example stock. Every price in this course comes from the Black-Scholes model for one example stock: price $100, volatility 25% a year, interest rate 4%, no dividends, 90 days to expiration. Real quotes differ. Full disclosures →

The bull call spread

You buy the 100 call for $5.43 and sell the 110 call for $1.89. The net cost is $3.54 a share, or $354. The 100 call alone costs $543.

Buy the 100 call and sell the 110 call, for a net $354. The chart shows the profit per contract at expiration for each stock price. The dot marks the break-even price.

Your largest gain is $646, if the stock ends at $110 or higher. That is the $10 width of the spread, minus the cost, times 100. You break even at $103.54, and the largest loss is the $354 that you paid.

The bear put spread

The bear put spread is the same idea for a fall. You buy the 100 put and sell the 90 put, for a net cost of $333. The largest gain is $667 at $90 or lower, and you break even at $96.67.

Credit spreads

A credit spread pays you at the start. In a bull put spread, you sell the 95 put and buy the 90 put. You receive $129 net.

Sell the 95 put and buy the 90 put, for a net credit of $129. The chart shows the profit per contract at expiration for each stock price. The dot marks the break-even price.

You keep the $129 if the stock ends at $95 or higher. The largest loss is $371: the $5 width, minus the credit, times 100. The model gives a profit in 71% of cases.

The bear call spread works the same way above the stock. You sell the 105 call, buy the 110 call and receive $142. You keep it if the stock ends at $105 or lower, and the largest loss is $358.

Stock at expiration	Bull call 100/110	Bear put 100/90	Bull put 95/90	Bear call 105/110
$70	-$354	+$667	-$371	+$142
$80	-$354	+$667	-$371	+$142
$90	-$354	+$667	-$371	+$142
$95	-$354	+$167	+$129	+$142
$100	-$354	-$333	+$129	+$142
$105	+$146	-$333	+$129	+$142
$110	+$646	-$333	+$129	-$358
$120	+$646	-$333	+$129	-$358
$130	+$646	-$333	+$129	-$358

Two rules for every vertical spread

For a debit spread, the largest gain is the width minus the cost. The largest loss is the cost.
For a credit spread, the largest gain is the credit. The largest loss is the width minus the credit.

The long option limits the loss. It also costs money, so it reduces the gain. Lesson 10 explains what happens if the short option is assigned before expiration.

Key points

A vertical spread is one long option and one short option, with the same expiration.
The short option cuts the cost, and it also caps the gain.
You know the largest loss when you open the trade.

Sources

Fischer Black and Myron Scholes, The Pricing of Options and Corporate Liabilities, Journal of Political Economy, 1973, for the model that gives every price in this course.