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Horizontal Spread

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A Horizontal Spread, also called time or calendar spread, is constructed with the same strike price and differing monthly expiration dates. Horizontal spreads split into long or short categories based on their construction. These constructions also determine whether positions have an initial outflow or inflow. A horizontal debit sells the front month, and buys the back month. A horizontal credit buys the front month, and sells the back month. The construction also determines if calls rely on near term performance first and neutrality after, or neutrality first and performance after. Horizontal calls earn profit from expected performance in the near and long term.

Long Horizontal Call Debit Spread

Long Call Horizontal

How To Read/Interpret Option Diagram
A Long Call Horizontal Spread is used for assets which are expected to remain neutral or decrease marginally in the near term, and rise long term. The spread builder sells a call expiring in the near term, then buys a call expiring in the long term. This results in a net outlay to create the position which must be exceeded by performance. The investor hopes the underlying asset’s market price doesn’t rise above the sold call’s strike price in the short term, avoiding losses. After the sold call expires, the price needs to rise above the purchased call’s strike price to provide profit. This is the best case scenario.

The worst case scenario occurs when market price is substantially above or below the strike price of the short term call, and stays below the strike price of the long term call. If the price rises above the short term call, it may be exercised. If it falls too low beneath the short term call the chance of the long call being exercised steadily decreases, along with the position’s value. However, if it doesn’t rise above the long term call’s strike price plus the outlay for the position, it won’t generate profit.

Short Horizontal Call Credit Spread

Short Call Horizontal

How To Read/Interpret Option Diagram
A Short Call Horizontal Spread is used for assets which are expected to rise or fall substantially in the short term, and fall in the long term. The spread builder buys a call expiring in the near term, and sells a call expiring in the long term. Both calls should have the same strike price, creating a value difference that delivers an inflow when starting the position. The investor hopes that the market price rises high enough that both calls are in the money and exercised, or that prices fall low enough that neither call is exercised. In both cases, the initial inflow received is kept as the profit.

The worst case scenario is the call sold being exercised after the call purchased expires. That results in a naked call which has unlimited risk since prices can infinitely rise. If this occurs, you will be forced to sell the underlying asset without owning it. You will be forced into an open market purchase which will eliminate inflows from the position’s creation and create a loss. If prices begin to rise, the position can be neutralized by buying a long term call with the same expiration date and strike price as the sold call. The risk is neutralized but the cost will eliminate the net inflow earned when creating the position, resulting in a loss.

 

Long Horizontal Put Debit Spread

Long Put Horizontal

How To Read/Interpret Option Diagram
A Long Put Horizontal Spread is used for assets which are expected to remain neutral or increase marginally in the near term, and fall long term. The spread builder sells a put expiring in the near term, then buys a put expiring in the long term. This results in a net outlay to create the position which must be exceeded by performance. The investor hopes the underlying asset’s market price doesn’t fall below the sold put’s strike price in the short term. This avoids losses. After the sold put expires, the price needs to fall below the purchased put’s strike price to provide profit. This is the best case scenario.

The worst case scenario occurs when market price is substantially above or below the strike price of the short term put, and stays above the strike price of the long term put. If the price falls below the short term put, it may be exercised. If it rises too far above the short term put the chance of the long put being exercised steadily decreases, along with the position’s value. However, if it doesn’t fall below the long term put’s strike price minus the outlay for the position, profit won’t be earned.

Short Horizontal Put Credit Spread

Short Put Horizontal

How To Read/Interpret Option Diagram
A Short Put Horizontal Spread is used for assets which are expected to rise or fall substantially in the short term, and rise in the long term. The spread builder buys puts with a short term expiration date, and sells puts expiring long term. Both puts should have the same strike price resulting in value differences that deliver an inflow when creating the position. The investor hopes that the market price falls low enough that both puts are in the money and exercised, or that prices rise high enough that neither put is exercised. In both cases, the initial inflow received is kept as profit.

The worst case scenario occurs if the purchased put expires and the put sold is exercised. The result is a naked put. If a naked put is exercised you will be forced to buy the underlying asset at a higher price than its value. The inflow earned at the position’s creation will erode and potentially be replaced with a loss. This loss is only limited by the distance from the underlying market price to zero. If prices begin to fall, the position can be neutralized by buying a long term put with the same expiration date and strike price as the sold put. The risk is neutralized but the cost may completely eliminate the net inflow earned when creating the position, and result in a loss. This loss will be less than absorbing the losses created by the stock continuing to fall after the long put’s expiration.

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Option Profit Diagram Example

  • As you move to the right the underlying asset increases in value. The left side is lower in underlying price, while the right side is higher in underlying price.
  • As you move to the top the trade increases in profit. The gray horizontal line is the profit/loss difference point, the zero line where there is no profit and no loss. Higher above the line is higher in profit, lower below the line is higher in losses.
  • The blue line is the profit/loss at expiration. The purple line is the profit/loss now. Eventually the curving purple line will become the blue line.
  • A flat blue line below the grey zero line indicates limited losses at expiration. A flat blue line above the grey zero line indicates limited gains at expiration. A blue line that slopes down infinitely off the chart represents unlimited losses, while a line that slopes infinitely up represents unlimited gains.
  • A preference for limited loss trades is strongly recommended, remember that an estimated 60% to 70% of retail trader options expire worthless when purchased since prices need a reason to move in the money. If you have limited gains, they should preferably be both more likely than and higher than your potential losses. Always manage risk carefully.
  • Option diagrams created by TDAmeritrade “ThinkOrSwim” platform.