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Stock Repair

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Stock Repair overview

Stock repairs have limited profit potential, and while they do not define risk to the downside, the ratio spread-like structure lowers the break-even price on a long stock position held at a loss. The income collected from selling the spread helps increase the probability of recovering from the loss of the long stock position. A stock repair may be entered at no cost or for a credit.

Stock Repair market outlook

The stock repair strategy is utilized when an investor has incurred losses on a long stock position and wants to reduce the necessary price increase required to break even. The strategy limits future upside potential but is an alternative to simply holding the shares and waiting for the stock price to recover and/or adding shares to lower the original trade’s cost basis, which requires risking more capital. However, the best the stock repair strategy will do is break even on the original trade, but this comes at no further downside risk than already owning the shares of stock.

How to set up a Stock Repair

Stock repair is essentially a call ratio spread combined with a long stock position and consists of buying an at-the-money call and selling two out-of-the-money calls at a higher price. The strategy is used if the stock price has decreased since ownership was initiated. Therefore, the at-the-money long call option will be below the cost basis of the long stock shares. The short options become the break-even price for the original stock position.

The ratio spread may be opened at no cost, or result in a credit, and will help to lower the cost of the initial trade.

Stock Repair payoff diagram

The payoff diagram for a stock repair strategy combines the profit and loss outcomes of long stock ownership and a call ratio spread. The maximum potential profit will now be limited to the strike price of the short call options. However, the break-even point will now be reduced.

For example, if 100 shares of stock were purchased at $50, and the stock is now trading for $40, a stock repair strategy could be used to help reduce the cost of the position. One buy-to-open (BTO) order for a long call option is entered at-the-money of the current stock price of $40. Two sell-to-open (STO) orders for short call options are entered out-of-the-money above the long options at $45. If the long call is purchased for $400 and the short calls are sold for $200 each, the net cost of the position is $0. If the stock stays below $40, all options expire worthless.

A similar strategy could be employed for the next expiration month. If the underlying stock closes above $40 but below $45 at expiration, the short calls expire worthless, and the long call can be sold for its intrinsic value, which would bring in more credit and reduce the break-even point of the original stock position. The investor could choose to close his long shares of stock or open a new position for a later expiration date. (For example, if the stock was at $42, the stock repair would have collected $200. Selling the stock would result in a -$600 loss, which is better than the -$800 it would have experienced without the strategy).

If the stock price closes above $45 at expiration, all options will be in-the-money. The long call and one short call will cancel out, and the remaining short call would sell shares of stock at $45. This would result in a break-even result for the stock repair as the $500 gain on the long call cancels out the $500 loss on the long stock position. The downside is that if the stock position closes above $50, the position will still only break even.

Image of stock repair payoff diagram showing max profit, max loss, and break-even points

Entering a Stock Repair

Stock repair is a call ratio spread and consists of buying an at-the-money call and selling two out-of-the-money calls at a higher price for every 100 shares of stock owned. All three options have the same expiration date. The strategy is used on a stock position that has an unrealized loss in an attempt to reduce cost basis and increase the chances of breaking even.

The stock repair strategy is opened with the at-the-money long call at a strike price lower than the stock’s original purchase price. The short options are sold at a higher price and must offset the cost, or collect more money, than the cost to purchase the long call for the strategy to be effective.

For example, if 100 shares of the stock were purchased at $50 and are now trading at $40, the stock repair may be entered with buying-to-open (BTO) one long $40 call and selling-to-open (STO) two short $45 call options, all with the same expiration date. If the long call is purchased for $400, the two short options should collect at least $400 of credit for the strategy to be successful.

Exiting a Stock Repair

The mechanics of exiting a stock repair strategy will depend on the underlying stock price at expiration. If the stock price is above the short calls, all options will expire in-the-money, and the shares of stock will be sold at the strike price of the short calls. If the stock closes between the long call and short calls, the short calls will expire worthless, and the long call will be in-the-money. The long call and the stock could be sold simultaneously, or the long call could be sold for its intrinsic value, and a new repair strategy could be opened with a later expiration date. If the stock closes below the long call, all options expire worthless. The credit, if any, from the strategy would remain, but the overall position would still show a net loss, and a new repair strategy could be opened with a later expiration date.

Time decay impact on a Stock Repair

The effects of time decay are minimal on the stock repair strategy. The short calls are positively impacted by theta decay, while the long call is negatively impacted. However, the strategy is not looking to capitalize on time decay to be profitable, so it is not a factor in whether the stock repair is successful. The longer the options are from expiration when the strategy is initiated, the more the options will be worth, but this will apply to all of the options.

Implied volatility impact on a Stock Repair

The effects of implied volatility are minimal on the stock repair strategy. Implied volatility values will impact the pricing of the options when the position is opened, but all options will be affected similarly.

Adjusting a Stock Repair

Stock repair strategies are not typically adjusted during the trade. The strategy’s goal is to reduce the original stock position’s cost basis and lower the break-even point to a more realistic price. If the price of the underlying stock continues to fall, the short calls may be purchased and resold at a lower price, which will bring in more credit but will force the investor to sell shares of stock at a lower price if the stock is called away. If the credit received did not cover the lower strike price, the adjustment will result in a loss.

A stock repair may be adjusted if the investor decides they no longer want to break-even on the trade and believe the stock will continue to rise. If the stock price increases, the short calls could be purchased and either resold at a higher price and/or later expiration date. The position could be exited completely, but buying back the calls will cost more money than the position was initially opened for, so the outlook for the stock would need to be very bullish to eventually exceed the additional cost added to the position.

Rolling a Stock Repair

The stock repair may be rolled if the underlying stock price is above the long call strike at expiration, and the investor wishes to extend the position. Any in-the-money options could be bought or sold and reopened at a later expiration date and different strike prices if the stock price has changed. The stock repair position may be rolled if the underlying stock price is below the long call strike at expiration, and the investor wishes to extend the position for additional time to break even on the long stock position. Any in-the-money options could be bought or sold and reopened at a later expiration date and different strike prices if the stock price has changed.

Hedging a Stock Repair

Stock repairs are not typically hedged because the option strategy is an attempt to lower the break-even point on a position trading at a paper loss. Downside protection is not considered with a stock repair. Other options strategies should be considered if downside protection is desired.

FAQs

How to recover losing stocks?
The stock repair strategy can be used if your stock position is losing money and you want to reduce the amount required to break even. The options strategy limits profit potential but does not add risk. It is an active investing alternative to holding shares waiting for a rebound and/or adding more shares to lower the cost basis. The best the stock repair strategy will do is break even on the original trade.
What is the long call repair strategy?
The stock repair strategy is a combines a long stock position with a call ratio spread. The ratio spread may be opened at no cost, or result in a credit, and will help to lower the cost of the initial trade.

Buy an at-the-money call and sell two out-of-the-money calls at a higher price. You can use this strategy if your stock position is losing money.
What is the optimal time frame to use a stock repair strategy?
You can use the stock repair strategy on any timeframe. The option’s days until expiration in the call ratio spread may impact the cost of the long option and credit of the short options. However, since the repair strategy is designed to breakeven, the holding period for the stock shares is not as important.

Call Backspread

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Call Backspread overview

Call backspreads have three components: one short call option sold in-the-money below the current stock price and two out-of-the-money long call options purchased at a higher price. The long calls will have the same strike price. All three call options have the same expiration date. Call backspreads may be opened for a debit or a credit, depending on the options contacts’ pricing. However, call backspreads are typically established for a credit. The strategy looks to take advantage of a significant move up in the underlying stock and, if the position is opened for a credit, also has profit potential if the security moves lower.

Call Backspread market outlook

A call backspread is purchased when an investor is bullish and believes the underlying asset’s price will be above the long call strike prices at expiration. The profit potential is unlimited above the long calls. A slight increase in price is the worst scenario for a call backspread. The risk is limited if the underlying stock price decreases significantly. If the call backspread is opened for a credit, the position will profit from a decrease in price.

How to set up a Call Backspread

A call backspread consists of selling-to-open (STO) one short call option in-the-money and buying-to-open (BTO) two long calls out-of-the-money above the short call option. The number of contracts must have a ratio where more long calls are purchased than short calls are sold.

For example, 1 short call option would require 2 long call options. If the position is opened for a credit, the maximum loss is realized if the underlying stock price is at the strike price of the long call option at expiration, because the short call would be in-the-money and the long calls would expire worthless. The profit potential is unlimited beyond the long call options.

The debit paid or credit collected at entry will depend on how far in-the-money the short call option is and how far out-of-the-money the long call options are relative to the underlying stock price.

Call Backspread payoff diagram

The payoff diagram for a call backspread opened for a credit is V-shaped, with the left side of the “V” capped at the amount of credit received. The risk is defined at entry, while the profit potential is unlimited to the upside. The maximum loss is the width of the spread minus the credit received at entry. The max loss is realized if the underlying stock closes right at the strike price of the long call options at expiration. In this scenario, the short call would finish in-the-money, and the long calls would have no intrinsic value.

If the stock price closes below the short call at expiration, all options will expire worthless, and the credit received at entry would be realized as a profit. If the stock price closes above the long calls at expiration, all options would expire in-the-money and need to be closed to avoid exercise and assignment. The intrinsic value of the remaining long call option would remain. The width of the spread between the bear call spread, plus or minus the entry pricing, would equal the net profit.

For example, if a stock is trading at $48, and an investor believes the stock will close above $50 at expiration, a call backspread may be entered by selling-to-open (STO) one $45 call option and buying-to-open (BTO) two $50 call options. If the $45 call option received $5.00 in credit, and the two $50 call options cost $2.00 each, the position would create a $1.00 credit at entry. If the stock is at or below $45 at expiration, all of the calls expire worthless and the $100 initial credit received is realized as a profit. If the underlying stock price is $50 at expiration, the long $50 strike calls would expire worthless, and the short call will cost $5.00 to close. The $5.00 to close, minus the $1.00 initial credit, results in the maximum loss for the position of -$400.

If the stock is above $50 at expiration, the realized profit or loss would be the difference between the stock price and the long call price, multiplied by the number of long call contracts, plus the initial credit received, minus the intrinsic value of the in-the-money short call option. For example, if the stock closed at $52 at expiration, the net loss would be -$200. The short call would be in-the-money $7.00 and the two long calls would be in-the-money $2.00. The long calls would profit $400 ($2.00 ITM x2) + the initial credit of $100 = +$500. But, the short call would need to be closed for -$700.

There are two break-even prices for a call backspread: 1) the strike price of the short call plus the credit received and 2) the strike price of the short call plus two times the difference between the strike prices minus the initial credit. In the example above, the two break-even prices are $46 and $54. If the underlying stock is above the upper break-even price, the profit is unlimited to the upside.

Image of call backspread payoff diagram showing max profit, max loss, and break-even points

Entering a Call Backspread

A call backspread is a bear call credit spread with an additional call purchased at the same strike price as the long call in the spread. All options have the same expiration date.

To enter the position, sell-to-open (STO) a short call option and buy-to-open (BTO) long call options. The ratio of long calls to short calls must be greater than 1:1. Despite the bear call spread, the strategy is bullish. The call backspread has a similar payoff diagram and outlook as a single long call, but with an additional opportunity for profit on the downside when sold for a credit. The bear call spread reduces the price of the additional long call option and decreases the potential risk by bringing in a credit.

Call backspreads may be purchased for a debit or sold for a credit. The price at entry will depend on the width of the spread, how far in-the-money the short call option is, and how far out-of-the-money the long call options are relative to the underlying’s stock price.

Exiting a Call Backspread

A call backspread needs significant movement above the long call strike prices for maximum profit potential. If the underlying stock price is above the long calls at expiration, all three options are in-the-money and must be exited to avoid exercise and assignment. If the stock price is above the short call at expiration, the contract is in-the-money and needs to be closed to avoid assignment.

Profit or loss will depend on the pricing at entry. If the stock price is below the short call option, all contracts will expire worthless, and no action is needed. The credit to enter the position will remain.

Time decay impact on a Call Backspread

Call backspreads are a net long position. Therefore, time decay, or theta, works against the strategy. Every day the time value of an options contract decreases, which will hurt the value of the two long call options.

Implied volatility impact on a Call Backspread

Call backspreads benefit from an increase in the value of implied volatility. Higher implied volatility results in higher option premium prices. Ideally, when a call backspread is opened, implied volatility is lower than where it is at exit or expiration. The strategy relies on the value of the long options to be profitable. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Call Backspread

Call backspreads have a finite amount of time to be profitable. If the call backspread is sold for a credit at entry, and risk is limited by the structure of the position, call backspreads are typically not adjusted. The position may be rolled up or down if the stock price is not in the profit zone. Call backspreads include at least one short contract. Therefore, assignment is a risk any time before expiration.

External factors, such as dividends, may need to be considered when deciding to adjust or close a call backspread position. If an investor wants to avoid assignment risk, or needs to extend the trade into the future to allow the strategy more time to become profitable, the entire position can be closed and reopened at a future expiration date with the same strike prices or new positions.

Rolling a Call Backspread

Call backspreads require the underlying stock price to be above a specific price at expiration. If the position is not profitable and an investor wishes to extend the trade’s length, the spread may be closed and reopened for a future expiration date. Because more time equates to higher options prices, the rollout may cost money and add risk to the position. The strike prices of the options in a call backspread may also be rolled up or down to reflect any change in price from the underlying asset.

Hedging a Call Backspread

It may be unnecessary to hedge call backspreads because the strategy is a risk-defined position with a clear payoff diagram. The strategy is bullish, and protection from lower movement in the underlying stock is not needed because the bear call spread defines the risk to the downside and a sharp decline in the underlying security will result in a profit equal to the amount of credit received at entry.

FAQs

What is a call backspread options strategy?
A call backspread is a multi-leg, risk-defined, bullish strategy, with unlimited profit potential. The strategy looks to take advantage of a significant move up in the underlying stock while limiting downside risk. A call backspread consists of selling-to-open (STO) one short call option in-the-money and buying-to-open (BTO) two long calls above the short call option and out-of-the-money. The number of contracts must have a ratio where more long calls are purchased than short calls are sold.

A call backspread is purchased when an investor is bullish and believes the underlying asset’s price will be above the long call strike prices at expiration. The profit potential is unlimited above the long calls.
What is an example of a call ratio backspread?
If a stock is trading at $48, and you believe the stock will be above $50 at expiration, you can enter a call backspread by selling-to-open (STO) one $45 call option and buying-to-open (BTO) two $50 call options. If the $45 call option received $5.00 in credit, and the two $50 call options cost $2.00 each, the position would create a $1.00 credit at entry. If the stock is at or below $45 at expiration, all of the calls expire worthless and the $100 initial credit received is realized as a profit. If the underlying stock price is $50 at expiration, the long $50 strike calls would expire worthless, and the short call will cost $5.00 to close. The $5.00 to close, minus the $1.00 initial credit, results in the maximum loss for the position of -$400.

If the stock is above $50 at expiration, the realized profit or loss would be the difference between the stock price and the long call price, multiplied by the number of long call contracts, plus the initial credit received, minus the intrinsic value of the in-the-money short call option. For example, if the stock closed at $52 at expiration, the net loss would be -$200. The short call would be in-the-money $7.00 and the two long calls would be in-the-money $2.00. The long calls would profit $400 ($2.00 ITM x2) + the initial credit of $100 = +$500. But, the short call would need to be closed for -$700.
What is the call ratio backspread max loss?
The maximum loss for a call ratio backspread is the width of the spread minus the credit received at entry. The max loss is realized if the underlying stock closes right at the strike price of the long call options at expiration. In this scenario, the short call would finish in-the-money, and the long calls would have no intrinsic value.

Put Ratio

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Put Ratio Spread overview

Put ratio spreads have three components: one long put purchased in-the-money and two short puts sold at a lower strike price out-of-the-money. The short puts will have the same strike price. All three put options have the same expiration date. Put ratio spreads may be opened for a debit or a credit, depending on the pricing of the options contacts, but put ratio spreads are typically established for a credit. Ideally, the stock price closes at the short put strikes at expiration.

Put Ratio Spread market outlook

Put ratio spreads are market neutral to slightly bearish. The strategy depends on minimal movement from the underlying stock to be profitable. For the position to reach maximum profit potential, the underlying stock price would need to decline in price to close at the short strike prices at expiration. Therefore, a slightly bearish bias is an appropriate outlook for a put ratio spread.

If the put ratio spread is initiated for a credit, the profit potential is the amount of credit received plus the width of the spread between the long and short put options. However, if the underlying stock price increases above the long put option, a profit will still be realized. All options would expire worthless, and the initial credit received would remain. Put ratio spreads have undefined risk if the stock price experiences a significant move lower below the short puts.

A put ratio spread is used when the underlying asset is expected to stay within the range between the two strike prices before expiration.

How to set up a Put Ratio Spread

A put ratio spread is a bear put debit spread with an additional put sold at the same strike price as the short put in the spread. The bear put spread results in a risk-defined position with limited profit potential. The goal is for the stock price to close at the short strikes at expiration. This results in the short contracts expiring worthless, and the long put could be sold with the maximum intrinsic value.

If the underlying stock price rises above the long strike, all options expire worthless, and the maximum loss is limited to the debit paid or, if a credit was received at trade entry, the credit will be realized as a profit. However, because of the single naked put, if the stock price of the underlying asset falls below the short put options, the risk is unlimited until the stock reaches $0.

The debit paid or credit collected at entry will depend on how far in-the-money the long put option is and how far out-of-the-money the short put options are relative to the underlying’s stock price.

Put Ratio Spread payoff diagram

The put ratio spread payoff diagram illustrates the strategy’s different outcomes based on the underlying stock price. Ideally, the stock price closes at the short strike options at expiration. When a put ratio spread is entered, there is potential for either paying a debit or receiving a credit.

If a credit is received, the amount collected, plus the width of the strike prices, is the maximum potential profit for the position. If a debit is paid, the maximum potential profit is the width of the spread between the short and long strikes, minus the amount paid to enter the position

Maximum gain and loss are limited if the stock price exceeds the long put option. All contracts would expire worthless, and the premium paid or received at entry will remain for a profit or loss. Maximum loss is unlimited if the stock price exceeds the break-even point below the short puts.

For example, if a stock is trading at $48, a put ratio spread could be entered with one long put at $50 and two short puts at $45. Assume a $1.00 credit is received. If the stock closes at $45 the maximum profit potential is realized. $600 is the most that can be made on the trade (the width of the spread, $5, plus the $1.00 credit). The short puts will expire worthless, and the long put can be sold for $5, plus the initial $1.00 credit. If the stock closes at $39 on expiration, the short puts will cost $12 combined to exit, but the long put will be worth $11.

Because the position received $1.00 at trade entry, the position will break-even at expiration if the underlying stock is trading at $39. If the stock closes above $50, all options will expire worthless and the original credit of $100 will remain. If the stock closes below $39, the potential loss is unlimited until the stock reaches $0.

Image of put ratio spread payoff diagram showing max profit, max loss, and break-even points

Entering a Put Ratio Spread

A put ratio spread is a bear put spread with a naked put option sold at the same strike price as the short put option in the spread. Put ratio spreads consist of buying-to-open (BTO) one in-the-money long put option and selling-to-open (STO) two out-of-the-money short put options below the current stock price. All options have the same expiration date.

The amount of contracts is variable, but the most common ratios are 2:1, 3:2, and 3:1. For example, if a stock is trading at $48, a put ratio spread could be entered with one long put at $50 and two short puts at $45.

Entering a put ratio spread may result in receiving a credit or paying a debit. The premium depends on multiple factors, including the width of the spread, how far in-the-money and out-of-the-money the options are, and implied volatility skew. For example, if the marketplace perceives an asset to be very bearish in the future, out-of-the-money options may be more expensive than normal, relative to the in-the-money option.

Exiting a Put Ratio Spread

A put ratio spread will experience its maximum profit potential if the stock price is exactly the same as the short strike options at expiration. In this scenario, or if the stock price closes above the short options and below the long option, the short put options expire worthless. The long put option that is in-the-money may be sold.

If the stock price closes above the long put option, all three options will expire worthless, and no further action will be needed. If the stock price closes below the short put options, all three options will be in-the-money and need to be closed if exercise and assignment are to be avoided.

Time decay impact on a Put Ratio Spread

Time decay, or theta, works in the advantage of the put ratio spread. Every day the time value of an options contract decreases, which will help to lower the value of the two short puts. Ideally, the underlying stock experiences minimal movement, and theta will exponentially lose value as the strategy approaches expiration. The decline in time value may allow the investor to purchase the short options contracts for less money than initially sold, while the in-the-money long option will retain its intrinsic value.

Implied volatility impact on a Put Ratio Spread

Put ratio spreads benefit from a decrease in the value of implied volatility. Lower implied volatility results in lower option premium prices. Ideally, when a put ratio spread is initiated, implied volatility is higher than where it will be at exit or expiration. Lower implied volatility will help to decrease the value of the two short puts more rapidly. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the short options.

Adjusting a Put Ratio Spread

Put ratio spreads may be adjusted before expiration to extend the duration of the trade or alter the ratio in the spread. If the underlying security drops and challenges the short puts, buying additional long puts to reduce the put spread to a 1:1 ratio caps the position’s risk. Adjustments will most likely come with additional cost to the position, which will increase the risk, lower the profit potential, and narrow the break-even points. Furthermore, because put ratio spreads consist of two short contracts, assignment is a risk any time before expiration.

External factors may need to be considered when deciding to adjust or close a put ratio spread position. If an investor wants to avoid assignment risk, and/or needs to extend the trade into the future to allow the strategy more time to become profitable, the entire position can be closed and reopened at a future expiration date with the same, or new, strike prices. Typically, if the stock moves below break-even point, the position is closed instead of adjusted.

Rolling a Put Ratio Spread

Put ratio spreads require the underlying stock price to be at or near a specific price at expiration. If the position is not profitable and an investor wishes to extend the length of the trade, the put ratio spread may be closed and reopened for a future expiration date. Because more time equates to higher options prices, the rollout may cost money and add risk to the position, depending on the spread’s initial credit or debit.

If the stock price has moved below the short put options, there may be an opportunity to close out the existing position and enter a new spread with new strike prices closer to the underlying asset’s current price. However, doing so would not make sense if the new net debit paid exceeds the spread’s width, as the position would no longer be profitable.

Hedging a Put Ratio Spread

The most common hedge for a put ratio spread is the purchase of additional long puts to reduce the spread ratio. Purchasing additional long put options converts the put ratio spread into a bull or bear put spread, depending on the security outlook at the time of the hedge. Protection from higher movement in the underlying stock is not necessary because the long put option has defined risk to the upside.

However, if an investor wants to protect against a significant decrease in the stock price, a long put option may be purchased below the short strikes. This would effectively create a bull put spread and protect against a decline in the underlying stock price. If the stock moves below the break-even point, the position may be closed instead of hedged.

FAQs

What is a put ratio spread?
A put ratio spread is a multi-leg, neutral strategy with undefined risk and limited profit potential. The strategy looks to take advantage of a drop in volatility, time decay, and little or no movement from the underlying asset.

A put ratio spread is a bear put debit spread with an additional short put sold at the same strike price and expiration date as the spread’s short put. The put debit spread results in a risk-defined position with limited profit potential. The goal is for the stock price to close at the short strikes at expiration. This results in the short contracts expiring worthless, and the long put could be sold with the maximum intrinsic value.
Are put ratio spreads bullish or bearish?
Put ratio spreads are market neutral to slightly bearish. The strategy depends on minimal movement from the underlying stock to be profitable. For the position to reach maximum profit potential, the underlying stock price would need to decline in price to close at the short strike prices at expiration. Therefore, a slightly bearish bias is an appropriate outlook for a put ratio spread.
What is a 2:1 ratio put spread?
A 2:1 ratio put spread, or put ratio spread, is a bear put spread with a naked put option sold at the same strike price as the short put option in the spread. Put ratio spreads consist of buying-to-open (BTO) one in-the-money long put option and selling-to-open (STO) two out-of-the-money short put options below the current stock price. All options have the same expiration date.

The amount of contracts is variable, but the most common ratios are 2:1, 3:2, and 3:1. For example, if a stock is trading at $48, a put ratio spread could be entered with one long put at $50 and two short puts at $45.

Put Diagonal

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Put Diagonal Spread overview

Put diagonal spreads consist of two put options. Put diagonals can be bullish or bearish depending on their setup.

Put diagonal spreads are bullish when a short put option is sold, and a long put option is purchased at a lower strike price and a later expiration date than the short put.

A bullish put diagonal spread is a combination of a put credit spread and a put calendar spread and is typically opened for a credit.

Bearish put diagonal spreads may be opened for a debit. This strategy guide focuses on bullish put diagonal spreads.

The strategy is successful if the underlying stock price is above the short put at the front-month expiration. The back-month long put option serves as protection and defines the strategy’s risk if the stock price is below the short put at the front-month expiration.

Put Diagonal Spread market outlook

A put diagonal spread is entered when an investor believes the stock price will be neutral or bullish short-term. The near-term short put option benefits from a rise in price from the underlying stock, similar to a bull put spread. The long put option will retain value better than a standard bull put spread because of its extended time horizon. An increase in volatility will also help add value to the long contract’s premium and potentially help offset a decline in value from the increasing stock price.

The objective is for the underlying stock price to close above the short put option at the first expiration date. The short put option would expire worthless, and the long put option would still have extrinsic value. At this point, an investor could choose to close the long put option or continue to hold the position if they believe the stock will reverse and go lower. Another short put option could also be sold to bring in additional credit. The short contract would need to have the same expiration date as the long put. This would create a traditional spread position.

How to set up a Put Diagonal Spread

A put diagonal spread is a combination of a bull put credit spread and a put calendar spread. A put diagonal spread is created by selling-to-open (STO) a put option and buying-to-open (BTO) a put option at a lower strike price, with a later expiration date.

Put diagonal spreads are typically opened for a credit, though a debit may be paid. The pricing at entry is dependent on the width of the spread between the two strike prices and the time until the expiration of the contracts. A tight spread width will result in a larger debit because the long option will be closer to the money and have more value. More time until expiration equates to more expensive options pricing and will also impact whether the position is opened for a debit or credit.

The width of the spread, minus the initial credit, is the maximum risk for the trade if the short put option is in-the-money and both options are closed at the front-month expiration. If the short put expires out-of-the-money, the long put may be sold for its extrinsic value. The credit received from selling the long put, plus the original credit received, will be the realized profit. The profit potential is unlimited if the short put expires worthless and the underlying stock price drops and/or implied volatility has a significant increase.

Put Diagonal Spread payoff diagram

The payoff diagram for a put diagonal spread is variable and has many different outcomes depending on when the options trader decides to exit the position. The maximum risk is defined at entry by the width of the spread minus the credit received.

If the stock price is below the short put at the front-month expiration, the option would need to be exited to avoid assignment. The long put may also be sold at the front-month expiration, or the investor could continue to hold the option if they believe the stock price will continue to decline. This would increase the maximum risk on the trade as the long put has the potential to expire out-of-the-money worthless.

If the stock price is above the short put strike at the front-month expiration–which is the goal of the diagonal spread–the short contract will expire worthless. The long put option will still have extrinsic time value. The investor can choose to exit the long put at this point or continue to hold the position.

For example, suppose a stock is trading at or above $50, and an investor believes the stock will stay above $50 in the near future. In that case, a put diagonal spread could be entered by selling a $50 put option and purchasing a $45 put option with a later expiration date. If the position collects $1.00 in credit, the max loss at the front-month expiration would be -$400.

The max potential profit will be variable and depend on whether the long put is closed at the front-month expiration. However, if a credit is collected when the trade is entered, and the short put expires worthless, the $100 credit will be a guaranteed profit. The long put could be sold at the front-month expiration to create additional profit, or the long position could be held if the investor believes the underlying stock price will decline.

Image of put diagonal spread payoff diagram showing potential profit and loss outcomes

Entering a Put Diagonal Spread

A put diagonal spread consists of selling-to-open (STO) a short put option and buying-to-open (BTO) a long put option at a lower strike price and a later expiration date.

For example, suppose a stock is trading at or above $50, and an investor believes the stock will stay above $50 in the near future. In that case, a put diagonal spread could be entered by selling a $50 put option and purchasing a $45 put option with a later expiration date. The farther out-of-the-money the strike prices are at trade entry, the more bearish the outlook on the underlying stock price.

Exiting a Put Diagonal Spread

The decision to exit a put diagonal spread will depend on the underlying asset’s price at the short put contract’s expiration. If the stock price is above the short put, the option will expire worthless. The long put option will be out-of-the-money and have time value remaining. The extrinsic time value will depend on the length of time until expiration and the strike price relative to the stock price.

Time value, or theta, works against the long option, and the contract will lose value exponentially as it approaches expiration. A sell-to-close (STC) order will be entered when the investor wishes to exit the long put position. If the underlying stock price is below the short put at the first expiration date, both options may be closed to exit the position. This will result in the maximum loss on the trade.

If the investor chooses only to close the in-the-money short put option, more risk is possible. The stock could reverse, and the long put option will lose value. However, if the stock price were to decrease, a profit could still be realized.

Time decay impact on a Put Diagonal Spread

Time decay, or theta, will positively impact the front-month short put option and negatively impact the back-month long put option of a put diagonal spread. Typically, the goal is for the short put option to expire out-of-the-money. If the stock price is above the short put at expiration, the contract will expire worthless. The passage of time will help reduce the full value of the short put option.

The time decay impact on the back-month option is not as significant early in the trade, but the theta value will increase rapidly as the second expiration approaches. This may influence the decision related to exiting the position.

Implied volatility impact on a Put Diagonal Spread

Implied volatility has a mixed effect on put diagonal spreads. The bull put spread component of the diagonal spread will be negatively impacted by increased implied volatility while the calendar spread will benefit. Ideally, the front-month short put option will expire out-of-the-money and be unaffected by changes in implied volatility. The position will experience the most profit if volatility is higher at the time of the second expiration. However, the stock price will need to be above the options’ strike price at the first expiration.

If implied volatility increases significantly early in the first expiration, the spread between the two contracts will decline. After the near-term expiration, increased implied volatility helps the position. Higher implied volatility means there is a greater expectation of a large price change, which is ideal for the remaining long put position that is out-of-the-money when the first contract expires.

Adjusting a Put Diagonal Spread

Put diagonal spreads can be adjusted during the trade to add credit. If the underlying stock price increases rapidly before the first expiration date, the short put option can be purchased and sold at a higher strike closer to the stock price. This will collect premium, but the risk increases to the adjusted spread width between the strikes of the near-term expiration contract and long-term expiration contract if the stock reverses. If the short put option expires out-of-the-money, and the investor does not wish to close the long put, a new position may be created by selling another short put option.

The ability to sell a second put contract after the near-term contract expires or is closed is a key component of the put diagonal spread. The spread between the short and long put options would need to be at least the same width to avoid adding risk. Selling a new put option will collect more credit, and may even lead to a risk-free trade with unlimited upside potential if the net credit received is more than the width of the spread between the options.

Rolling a Put Diagonal Spread

The short put option of a put diagonal spread can be rolled higher if the underlying stock price rises. The short put may be purchased and resold at a higher strike price to collect more credit and increase profit potential. Ideally, the stock still closes above the short option, so it expires worthless. The long put option may have extrinsic value remaining to help reduce the loss or potentially make a profit.

Hedging a Put Diagonal Spread

Put diagonal spreads are typically not hedged. The strategy has a specific goal and defined risk. The position may be adjusted higher if the underlying stock price rises. The put diagonal spread holder may do nothing and continue to hold the position, let the near-term contract expire worthless, and see if the underlying security drops during the longer-term expiration. If the near-term contract is closed and a new contract is sold, the long put position may potentially be “free” if the combined credits of the two short contracts exceed the debit required to enter the long put position. The reduced cost of the long put minimizes or eliminates the break-even point on the position.

FAQs

What is a diagonal put spread?
A put diagonal spread is a risk-defined options strategy with limited profit potential. Put diagonal spreads are bullish and capitalize on time decay.

A put diagonal spread is a combination of a put credit spread and a put calendar spread. A put diagonal spread is created by selling-to-open (STO) a put option and buying-to-open (BTO) a put option at a lower strike price, with a later expiration date.
Is a diagonal put spread bullish or bearish?
Diagonal put spreads are bullish. You can exit the strategy for a profit if the underlying stock price is above the short put option at the front-month expiration and the long put with a later expiration date is sold.

Holding the long put past the short put’s expiration date increases risk and profit potential. A long put is bearish; if the stock price falls, the long put will benefit.
What are the advantages of put diagonal spreads?
You can open a put diagonal spread if you believe the stock price will be neutral or bullish short-term. The near-term short put option benefits from the underlying stock’s price increasing, time decay, and decreasing volatility, similar to a bull put spread. The long put option will retain value better than a standard bull put spread because of its extended time horizon. An increase in volatility will also help add value to the long contract’s premium and potentially help offset a decline in value from the increasing stock price.
What are the risks of a put diagonal spread?
A put diagonal spread’s payoff diagram is variable and has multiple outcomes depending on when the options trader chooses to exit the position. The maximum risk is defined at trade entry, if you close both options at the front month expiration. To calculate the max risk, subtract the credit received by the spread’s width.

Strap

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Strap overview

A strap is very similar to a long straddle, except there are two long calls instead of one, which makes straps more expensive but allows for more profit potential. The two long calls give the strap its bullish bias but requires a larger directional move than a straddle because the stock price must move enough to cover the cost of three long options. A sharp move up will result in twice the profit, while the strap may also capitalize on a large move down.

A long strip is the reverse of the strap and is neutral to bearish. Two long puts and one long call are purchased at the same strike price and the same expiration date.

Long Strap market outlook

Long straps are bullish but will capitalize on a strong move in either direction. Straps require a large enough move in the underlying asset to exceed the three long options’ combined break-even price. Long straps require a significant price change and/or increased volatility before expiration to realize a profit.

A sharp rise in implied volatility typically accompanies large moves in stock prices. This will benefit the strap because the strategy depends on both movement in the underlying security’s price and implied volatility to collect higher premiums when the trade is exited.

How to set up a Long Strap

A long strap is made up of two long call options and a long put option centered at the same strike price with the same expiration date. Straps are typically purchased at-the-money of the underlying asset.

The combined cost of the long calls and long put define the maximum risk for the trade. The long strap will capitalize on a large move in either direction and/or an increase in implied volatility, though a move up in the stock price is more profitable. The potential profit is unlimited beyond the debit paid to enter the trade.

Long Strap payoff diagram

The long strap payoff diagram resembles a slightly skewed “V” shape, where the larger gains will be realized on the call side. The maximum loss on the trade is defined at entry by the combined cost of the three long options contracts. The profit potential is technically unlimited, though a large move in one direction before expiration is required. The strap’s net profit would be the credit received when the position is closed, minus the premium paid to purchase the options. The break-even point for the trade is the combined cost for the three options contracts above or below the strike price.

For example, if a long strap is purchased for $10.00 at the $50 strike price, the stock would need to be above $60 or below $40 at expiration to realize a profit.

Image of long strap payoff diagram showing max profit, max loss, and break-even points

Entering a Long Strap

The long strap is two long calls and a long put purchased simultaneously at the same strike price for the same expiration date. For example, suppose an investor believes a $50 stock will experience a large increase in price and/or volatility before expiration. In that case, a long strap could be entered by purchasing two $50 long call options and one $50 long put option. Higher volatility will equate to higher option prices. The longer the expiration date is from trade entry, the more the options will cost.

Exiting a Long Strap

A long strap looks to capitalize on a sharp move (preferably up) in stock price, implied volatility, or both. If the underlying asset moves far enough before expiration and/or implied volatility expands, the trade is exited by selling-to-close (STC) the three long options contracts. The difference between the cost of buying the premiums and selling the premiums is the net profit or loss on the trade.

At expiration, it is likely that one or more of the options will be in-the-money and will need to be exited to avoid assignment. Typically, straps are exited before expiration because an investor will want to sell the options before the extrinsic value disappears.

Time decay impact on a Long Strap

Time decay, or Theta, works against the long strap strategy. Every day the time value of the long options contract decreases. Ideally, a large move in the underlying stock price occurs quickly, and an investor can capitalize on all the remaining extrinsic time value by selling the option.

Implied volatility impact on a Long Strap

Long straps benefit from an increase in the value of implied volatility. Higher implied volatility results in higher option premium prices. Ideally, when a long strap is initiated, implied volatility is lower than it is at exit or expiration. Future volatility, or Vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the straddle options.

Adjusting a Long Strap

Long straps have a finite amount of time to be profitable and have multiple factors working against their success. If the underlying stock does not move far enough, fast enough, and/or volatility decreases, the strap will lose value and result in a loss. Long straps can be adjusted like most options strategies but will almost always come at more cost and add a debit to the trade and extend the break-even points.

If a stock has not moved into a profitable zone by expiration, the in-the-money option(s) can be sold (the other option(s) will be out-of-the-money), and a new strap can be purchased for a later expiration. This adjustment can also be done before expiration if an investor wishes to recapture some of the premium before the contracts expire worthless. Keep in mind that this will require the stock to make an even larger move than the original trade and add risk by increasing the amount of capital committed to the trade.

Rolling a Long Strap

Long straps can be rolled out to a later expiration date if the stock price or implied volatility has not moved enough to realize a profit. To roll out the strap, sell-to-close (STC) the current position and buy-to-open (BTO) a new position for a later expiration. The new strap may be at the same strike price or can be adjusted up or down to reflect any changes in the stock price.

The downside to rolling out long options is that the roll will most likely cost money and, therefore, increase the original trade risk. The risk is still defined, but the additional debit will not only create a higher potential maximum loss, but also require the underlying stock to move more to exceed the break-even point.

Hedging a Long Strap

Hedging a long strap may be a proactive way to help retain some profits if the stock has moved sharply early in the expiration period while minimizing the overall risk of the position. Long straps need a sustained move in one direction to realize a profit. However, stocks can move quickly and retrace, leaving a once profitable position worthless.

If the underlying stock moves up or down away from the strike price, an investor may choose to hedge against a future move back in the opposite direction of the initial move. If the underlying asset moves up, an investor may choose to roll up the long put option. Conversely, if the underlying asset moves down, the long calls could be rolled down.

For example, if an at-the-money long strap is purchased at $50 for $10.00, and the stock immediately moves up to $55, one way to hedge the position would be to sell-to-close (STC) the $50 put and buy-to-open (BTO) the $55 put for the same expiration date. This will add cost to the position, but now a portion of the position can be closed for no less than $5.00 (the width of the spread between the call and put options).

If the stock price continues above $55, the strap’s bullish bias will benefit, while having additional protection from the higher-strike put. If the stock price falls below $50, the $55 strike put will trade for more than $5.00. This is a way to minimize the risk of the trade while allowing the strap to still capture profit if the stock moves dramatically in one direction.

To fully hedge the strap, the amount of long options contracts needs to be equal. For example, in the previous scenario, an additional put would need to be purchased or one of the long calls would need to be sold. If the call is sold, a profit would be realized, which would reduce the overall cost of the trade and minimize risk. If an additional put were purchased, the cost and risk would increase, but the potential profit would increase as well if the stock ultimately moved substantially lower.

FAQs

What is a strap option?
A long strap is a multi-leg, risk-defined, neutral to bullish strategy that consists of buying two long calls and one long put at the same strike price for the same expiration date. The strategy looks to take advantage of a rise in volatility and a large move in either direction from the underlying stock.
Is an option strap strategy bullish?
Long straps are bullish, but can benefit from a large move in either direction. A strap performs similar to a long straddle, but there are two long calls instead of one, making straps more expensive and potentially more profitable. The two long calls give the strap its bullish bias but requires a larger directional move than a straddle because the stock price must move enough to cover the cost of three long options. A sharp move up will result in twice the profit, while the strap may also capitalize on a significant move down.
What is an example of a strap option?
If you believe a $50 stock will experience a large increase in price and/or volatility before expiration, you could open a long strap by purchasing two $50 long call options and one $50 long put. Higher volatility will equate to higher option prices. The longer the expiration date is from trade entry, the more the options will cost.

Put Calendar

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Put Calendar Spread overview

Put calendar spreads consist of two put options. A short put option is sold, and a long put option is purchased at the same strike price but with a later expiration date than the short put. A put calendar spread looks to capitalize on minimal price movement and time decay in the near-term put option and rising volatility in the long-term put option. The strategy is successful if the underlying stock price stays at or above the strike price of the short put before the front-month expiration, then moves below the strike price of the back-month long put option, preferably with increasing volatility. A debit will be paid to enter the position because the longer-dated option will be more expensive. The initial cost to enter the trade is the maximum loss at the front-month expiration.

Put Calendar Spread market outlook

A put calendar spread is purchased when an investor believes the stock price will be neutral or slightly bullish short-term. The position would then benefit from a decrease in price and increasing volatility after the short-term contract expires and before the longer-dated contract is closed. A more neutral outlook is typically expressed with a call calendar spread than a put calendar spread because of the greater time value inherent in call options relative to put options. The position has a maximum loss defined by the cost to enter the trade. If the underlying stock price is below the short put at expiration, the long put may be exercised to cancel out the assignment of the long shares. The position would then be closed for a max loss.

Ideally, the stock price is at or just above the short put at the time of expiration, and the short contract would expire worthless. A decision will then need to be made to either exit the long put position or wait to see if the stock price declines and/or implied volatility increases before the second expiration date. The further out-of-the-money the strike prices are at trade entry, the more bearish the outlook on the underlying security.

How to set up a Put Calendar Spread

A put calendar spread is created by selling-to-open (STO) a short-term put option and buying-to-open (BTO) a put option with a later expiration date. Both put options will have the same strike price. Long put calendar spreads will require paying a debit at entry.

The initial cost is the maximum risk for the trade if the short put option is in-the-money and/or both options are closed at the front-month expiration. The profit potential is unlimited if the short put expires worthless, and the underlying stock price declines and/or implied volatility has a significant increase.

Put Calendar Spread payoff diagram

The payoff diagram for a put calendar spread is variable and has many different outcomes depending on when the options trader decides to exit the position. The maximum risk is defined at entry by the debit paid to enter the spread if both options are exited at the first expiration.

If the stock price is below the put options’ strike at the front-month expiration and the investor chooses to close both options, the loss would be the trade’s initial cost. If the stock price is above the short put strike at expiration–which is the goal of the calendar spread–the short contract will expire worthless. The long put option will still have extrinsic time value remaining. The investor can choose to exit the long put at this point or continue to hold the position with no increased risk.

At the near-term expiration, the payoff diagram slightly resembles an inverted V. After the near-term expiration, if the long put option is held, the payoff diagram is the same as a long put. If the stock price falls and/or implied volatility increases before the long put’s expiration date, the position will gain value. If the stock price rises, the extrinsic value of the long put will decrease.

For example, suppose a stock is trading at or above $50, and an investor believes the stock will stay above $50 before the first expiration. In that case, a put calendar spread could be entered by selling a $50 put option and purchasing a $50 put option with a later expiration date. Assume the short put was sold for $2.00, and the long put was purchased for $4.00. The initial debit of -$2.00 would be the maximum loss at the first expiration if both options are closed. If the short put is out-of-the-money at expiration, it will expire worthless, and the long call could be sold for its extrinsic value. The payoff diagram below illustrates a $100 profit as the outcome with the underlying stock trading at-the-money at the first expiration if the long put is sold with $3.00 of extrinsic value remaining.

However, the long put’s value may increase or decrease after the first expiration, depending on the price movement of the underlying security. If the short put is in-the-money at the first expiration and the long put is not sold simultaneously, the maximum risk may exceed -$200 if the stock subsequently reverses before the second expiration.

 Image of put calendar spread payoff diagram showing potential profit and loss outcomes 

Entering a Put Calendar Spread

A put calendar spread consists of selling-to-open (STO) a short put option and buying-to-open (BTO) a long put option at the same strike price but with a later expiration date.

For example, if a stock is trading at or above $50, and an investor believes the stock will stay above $50 in the near future, a put calendar spread could be entered by selling a short-term $50 put option and purchasing a $50 put option with a later expiration date. The long put contract will have a higher premium because it has more extrinsic time value, so the position will cost money to enter. The debit paid will be the maximum risk for the trade at the expiration of the first contract.

The farther out-of-the-money the strike prices are at trade entry, the more bearish the outlook on the underlying’s price.

Exiting a Put Calendar Spread

The decision to exit a put calendar spread will depend on the underlying asset’s price at the short put contract’s expiration. If the stock price is above the short put, the option will expire worthless. The long put option will be out-of-the-money and have time value remaining. The extrinsic time value will depend on the length of time until expiration and the strike price relative to the stock price.

Time value, or theta, works against the long option, and the contract will lose value exponentially as it approaches expiration. A sell-to-close (STC) order will be entered when the investor wishes to exit the position. The credit received when selling the long option, minus the original debit paid, will result in a profit or loss. If the underlying stock price is below the short put at the first expiration date, both options may be closed to exit the position. This will result in the maximum loss on the trade.

If the investor chooses only to close the in-the-money short put option, there is potential for more risk. The stock could reverse, and the long put option will lose value. However, if the stock price were to decrease, a larger profit could be realized. Legging out of a put calendar spread can increase the risk beyond the initial debit paid but creates the highest profit potential.

Time decay impact on a Put Calendar Spread

Time decay, or theta, will positively impact the front-month short put option and negatively impact the back-month long put option of a put calendar spread. Typically, the goal is for the short put option to expire out-of-the-money. If the stock price is above the short put at expiration, the contract will expire worthless. The passage of time will help reduce the short put option’s time value prior to expiration.

The time decay impact on the back-month option is not as significant early in the trade, but the theta value will increase rapidly as the second expiration approaches. This may influence the decision to exit the position.

Implied volatility impact on a Put Calendar Spread

Implied volatility has a mixed effect on put calendar spreads. Generally, put calendar spreads benefit from an increase in implied volatility. Ideally, the front-month short put option will expire out-of-the-money and be unaffected by changes in implied volatility. The position will experience the most profit if volatility is higher at the time of the second expiration. However, the stock price will need to be above the options’ strike price at the first expiration for the put calendar spread to be successful.

If implied volatility increases significantly early in the near-term expiration, the spread between the two contracts will decline. After the near-term expiration, the more implied volatility, the better. Higher implied volatility means there is a greater expectation of a large price change which is ideal for the remaining long put position. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Put Calendar Spread

Put calendar spreads can be adjusted during the trade to increase credit. If the underlying stock price rises rapidly before the first expiration date, the short put option can be purchased and sold at a higher strike closer to the stock price to receive additional credit.

For example, if a put calendar spread was entered at $50, and the underlying stock has increased to $60 before the first expiration, the short put could be bought back and resold at $55. This will collect more premium to help offset the initial debit paid, but if the stock reverses, the risk will increase to at least $5.00, the adjusted spread width between the strikes of the near-term expiration contract and long-term expiration contract.

If the underlying stock fails to challenge the strike price before expiration, the spread value has typically widened, allowing the position to be closed for a small profit, and no adjustment is necessary.

Rolling a Put Calendar Spread

The short put option of a put calendar spread can be rolled higher if the underlying stock price rises. The short put may be purchased and resold at a higher strike price to collect more credit and increase profit potential. Ideally, the stock still closes above the short option, so it expires worthless. The long put option may have extrinsic value remaining to help reduce the loss or potentially make a profit.

Hedging a Put Calendar Spread

Put calendar spreads are not typically hedged. The strategy has a specific goal and defined risk. The position can be adjusted higher if the underlying stock price increases. The put calendar spread holder may do nothing and continue to hold the position, allowing the near-term contract to expire worthless, and see if the underlying security reverses during the longer-term expiration.

FAQs

What is a put calendar spread?
A put calendar spread is a risk-defined options strategy with unlimited profit potential. Put calendar spreads are neutral to bullish short-term and slightly bearish long-term. To open a put calendar spread, sell-to-open (STO) a short put option and buy-to-open (BTO) a long put option at the same strike price but with a later expiration date.

For example, if a stock is trading at or above $50, and you believe the stock will stay above $50 in the near future, you could enter a put calendar spread by selling a $50 put option and purchasing a $50 put option with a later expiration date. The long put contract will have a higher premium because it has more extrinsic time value, so you will likely pay a debit to enter the trade. The debit paid will be the maximum risk for the trade at the expiration of the first contract.
When to exit a calendar put spread?
The decision to exit a calendar put spread depends on the underlying asset’s price at the short put contract’s expiration and your future outlook for the stock. If the stock price is above the short put, the option will expire worthless. The long put option will be out-of-the-money and have time value remaining. The extrinsic time value will depend on the length of time until expiration and the strike price relative to the stock’s price.

Legging out of a put calendar spread can increase the risk beyond the initial debit paid but creates the highest profit potential. If you choose to only close the in-the-money short put option, there is potential for more risk. The stock could reverse, and the long put option will lose value. However, if the stock price were to decrease, a larger profit could be realized.
Is a put calendar spread bullish?
Put calendar spreads are bullish short-term and slightly bearish long-term.

LEAPS

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LEAPS overview

LEAPS function the same as a single-leg call or put option but have much longer maturities. Buyers have the right, but no obligation, to exercise an option before expiration. Sellers are obligated to the terms of the contract if assigned the options position.

In many ways, LEAPS are similar to holding a long-term position in a stock, but with defined risk and much lower capital allocation. LEAPS strategies are similar to short-term options strategies but often favor buying strategies over selling strategies because of the slower rate of time decay.

LEAPS are bought and sold like their short-term counterparts, and can have American or European-style expirations. LEAPS can be used in conjunction with other options strategies to define risk, hedge a position, or reduce the LEAPS contract’s cost basis.

LEAPS market outlook

LEAPS behave exactly like short-term options, but with a much longer time horizon. They can be used individually to generate income, speculate on future price movement, or to hedge against potential risk in other options or stock positions.

LEAPS can also be combined with other option contracts to create multi-leg strategies. The primary benefit of using LEAPS options is the reduced capital allocation required to enter a position relative to owning or shorting stock for the same extended period of time.

Furthermore, the downside risk is clearly defined at entry and limited to the premium paid.

For example, if an investor wanted to own 100 shares of a stock trading for $100, the initial capital required to enter the trade would be $10,000, all of which would be at risk if the underlying asset fell to $0. Similar exposure via a LEAPS call option would come at a fraction of the capital outlay.

LEAPS can also be sold to collect credit. They can be used with short or long term options contracts to create cost-effective and risk-defined strategies, or combined with stock to hedge the position. LEAPS are used in place of stock shares in strategies that combine stock ownership with short options contracts, like covered call writing.

How to set up LEAPS

LEAPS are initiated like any other options contract. An investor may buy-to-open (BTO) or sell-to-open (STO) a position by selecting a contract from the options chain. The main difference is the expiration date must be at least one year in the future to qualify as a LEAPS contract.

The longer time until maturity will naturally equate to much higher pricing, as the options will have significant extrinsic value.

The Greeks (Delta, Gamma, Vega, Theta, Rho) play a large role in the option’s pricing, as the extended timeframe means the option’s value is more sensitive to changes in implied volatility, interest rates, and price fluctuations of the underlying stock.

LEAPS payoff diagram

The payoff diagram for purchasing a single-leg LEAPS contract will resemble the same profit and loss potential as a long call or long put option. The risk is limited to the initial debit paid at entry and profit potential is unlimited.

The cost to enter a long LEAPS contract will be much higher than shorter-term options because of the longer time until expiration. This will impact the break-even points, which will be much farther from the strike price. The math remains the same: to be profitable, the stock price must be beyond the strike price plus the debit paid.

For example, if a long call option with a strike price of $100 is purchased for $20.00, the maximum loss is defined at -$2000 and the profit potential is unlimited if the stock continues to rise. However, the underlying stock must exceed $120 to realize a profit.

If a LEAPS call or put contract is sold, the initial credit received is still the maximum potential profit for the trade. In this scenario, much more credit will be collected than with shorter-term options, and the break-even range will be much larger. However, when selling naked options, the risk beyond the premium collected is undefined.

If multiple LEAPS are bought or sold to create multi-leg strategies, the payoff diagrams will be the same as the short-term strategy.

Image of LEAPS payoff diagram showing max profit, max loss, and break-even points

Entering LEAPS

Entering LEAPS is the same as entering short-term options contracts. The premiums and related relevant information will be available on the options chain. The options may be bought or sold or combined, just like any other options contract.

The most significant difference is the pricing relative to short-term options. LEAPS will have more expensive premiums, but that is the compromise for having capital-effective, long-term exposure to stocks.

Exiting LEAPS

Exiting LEAPS is the same as exiting short-term options contracts. If the option has American-style expiration, the position may be closed anytime before expiration by reversing the initial entry order.

For example, if a long call was purchased to initiate the position, it will be sold to exit. If it is sold for more than it was purchased, a profit will be realized.

American-style options can also be exercised prior to expiration. If the option has European-style expiration, exiting the position or early exercise is not a possibility. The option will be cash-settled on the expiration date.

Time decay impact on LEAPS

Time decay will have a minimal impact on a LEAPS extrinsic value for the majority of its lifetime. Time decay, or theta, increases exponentially as an option approaches the expiration date.

Typically, the effects of time decay will not significantly impact the option’s pricing until the last 60 days before expiration. Because LEAPS have at least one year of time value, theta is a significant component of the contract’s extrinsic value.

The more time until expiration an option has, the more opportunity the underlying asset has to experience price movement, and the more expensive the option’s price.

Implied volatility impact on LEAPS

Implied volatility has the potential to impact LEAPS significantly. If implied volatility increases substantially before expiration, the long options contract will benefit.

Conversely, implied volatility can have an adverse effect on an option’s premium. If volatility contracts before expiration, the price of the long contract will decrease.

Implied volatility, or vega, is impossible to predict and is relative, so what seems low currently may not be in the future.

Adjusting LEAPS

LEAPS can be adjusted like any options contract. For the duration of the contract, additional positions may be added to define risk, increase credit, or hedge against adverse price movement.

Because a LEAPS contract has so much time until expiration, investors may choose to wait to make adjustments.

Rolling LEAPS

LEAPS can be rolled if the option is approaching expiration and is still not profitable. However, the original pricing will be a large determinant in adjusting the contract for credit or debit.

If the underlying stock price has moved dramatically away from the profit target, or implied volatility has experienced large changes, it may be difficult to roll the position in a cost-effective manner.

Many factors will play a role in the decision to roll LEAPS as expiration approaches, but the mechanics are the same as adjusting any options strategy.

Because of the long-dated maturity of LEAPS, short-term contracts are often sold against long LEAPS positions. The short-term contracts may then be rolled from expiration period to expiration period to generate income, such as with a synthetic covered call strategy.

Hedging LEAPS

Because LEAPS have a long lifespan, the ability to hedge the position, or use the option to hedge other positions, is beneficial for the investor. LEAPS are often used to hedge existing long-term positions.

For example, if an investor has made the decision to hold a stock for many years, a long-dated put option may be purchased to hedge against future risk. Stock positions and options strategies can also be used to hedge LEAPS as well.

The extended timeframe of LEAPS contracts allows the investor a lot of flexibility in creating risk defined hedges or finding potential for more profit.

FAQs

What are LEAPS options?
Long-term equity anticipation securities (LEAPS) are options contracts with an expiration date longer than one year.

LEAPS function the same as a single-leg call or put option but have much longer maturities. Buyers have the right, but no obligation, to exercise an option before expiration. Sellers are obligated to the terms of the contract if assigned the options position.
What is an example of a LEAPS option?
A LEAPS option is an option contract with more than one year to expiration. LEAPS are initiated like any other options contract. An investor may buy-to-open (BTO) or sell-to-open (STO) a position by selecting a contract from the options chain. The main difference is the expiration date must be at least one year in the future to qualify as a LEAPS contract.
What is are the advantages of LEAPS?
LEAPS offer long-term exposure to an asset at a much lower capital allocation and with defined risk. If you want to be long 100 shares of a stock trading for $100, the initial capital required to enter the trade would be $10,000, all of which would be at risk if the underlying asset fell to $0. Similar exposure via a LEAPS call option would come at a fraction of the capital outlay.

Protective Put

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Protective Put overview

Protective puts are similar to purchasing car insurance: a premium is paid to protect against future risk, but the hope is that it will never be needed. Like car owners, investors are willing to pay a relatively small amount on a recurring basis to guarantee defined risk.

Protective Put market outlook

A protective put is purchased when an investor owns an asset and wants to protect against future downside price movement. Owning the long put defines risk by allowing the investor to sell stock at the long put option’s strike price. A protective put can be entered below the price of the long stock position to limit loss. If the underlying asset has increased in price since its purchase, the protective put could be placed above the original purchase price of the stock to secure a profit.

How to set up a Protective Put

Put options are listed on the option chain at various strike prices and expiration dates. The closer to the money the put option is, the more expensive the options contract. The more time until expiration, the more expensive the options contract.

Purchasing a protective put will require paying a debit and will increase the cost basis of the original long stock position by the amount of the premium paid. An investor will need to consider these factors when deciding where he or she would like to protect their downside risk and for how long.

Protective Put payoff diagram

A protective put will have a payoff diagram similar in appearance to a single-leg long call option. The maximum profit potential is unlimited if the underlying stock moves up and stays above the protective put strike price. The downside risk will be limited to the long put option’s strike price plus the cost of the premium to own the long put.

For example, if stock is owned at $100 and a protective put is purchased for $5.00 with a strike price of $95, the maximum risk for the position is $1000 per contract ($95 – $100 – $5 = -$10 x 100 shares per contract = -$1,000).

Image of a protective put payoff diagram showing max profit, max loss, and break-even points

Entering a Protective Put

Entering a protective put position is very similar to opening a single long put option, but long stock is either already owned or purchased in conjunction with the protective put. Buying the long protective put will cost money and therefore increase the long stock position’s cost basis, but that is the compromise for protecting the underlying asset from downside risk.

For example, if stock is purchased at $100 and a protective put is purchased at the $95 strike price for $5.00, the long stock position’s cost basis becomes $105, meaning the stock will have to rally above $105 to realize a profit.

Exiting a Protective Put

Exiting a protective put will depend on where the price of the underlying asset is at expiration. If the stock price is above the protective put’s strike price, the put will expire worthless. If the stock price is below the protective put’s strike price, and the investor wishes to exercise the put option, 100 shares per contract will be sold at the strike price, and the position will be closed.

Time decay impact on a Protective Put

Protective puts have extrinsic value like all options. Time decay, or Theta, will slowly decrease the value of the contract’s premium. However, because protective puts are purchased for protection and not speculation, time decay is not as important. Ideally, since long stock is owned, the goal for a protective put is to see the price of the stock increase, and the protective put expire worthless.

Implied volatility impact on a Protective Put

Implied volatility will have an impact on the pricing of protective puts. The higher the value of implied volatility, the more expensive the cost of the put option. Generally speaking, put options are more expensive than call options because investors are willing to pay a higher premium to protect from downside risk. When markets experience large price movements, implied volatility increases, and the cost of put options typically increases.

Adjusting a Protective Put

Protective put options positions can be managed during a trade as the price of the underlying stock moves. If the stock price rises, an investor may choose to move up the protective put to secure selling shares at a higher price.

To do so, a sell-to-close (STC) order would be entered to exit the original long put option position. This would collect a credit, but typically at a lower price than the option was originally purchased. A buy-to-open (BTO) order would be entered for a new long put option with a higher strike price. This will cost more than the put option that was sold, and the total amount debited would be added to the original premium paid to create a new cost basis. However, if the stock price has rallied high enough, the protective put could still guarantee a profit, even with the debits.

For example, if stock is owned at $100 and a protective put is purchased for $5.00 with a strike price of $95, and the stock subsequently increases to $120, the original $95 put may be sold (for less credit than was initially paid) and a new put may be opened at $115. If the new protective put costs an additional $5.00, the position would still guarantee a profit of at least $500.

Rolling a Protective Put

Protective put options that expire out-of-the-money at expiration have no value. To initiate a new protective put contract, a long put can be purchased for a future expiration date at the same strike price or a different strike price depending on where the underlying stock is trading.

Suppose the put is in-the-money at expiration, and the investor does not want to exercise their right to sell at that price (perhaps believing the stock will continue to rally in the future). In that case, the options contract can be rolled out to a future date by selling the original position and purchasing a new long put.

Hedging a Protective Put

Protective puts may be hedged to reduce the overall cost of the position. A short call can be sold above the stock price to collect a credit. This will limit the upside potential of the underlying stock position, but the premium received can offset the cost of the protective put. This is called a collar strategy.

FAQs

What is a protective put?
A protective put is an options strategy combined with long stock that defines the underlying asset’s downside risk. Protective puts are also known as married puts because the stock position and long put are “married” together to protect against a potential decrease in the stock’s price.

Protective puts are purchased when an investor owns an asset and wants to protect against future downside price movement. Owning the long put defines risk by allowing the investor to sell stock at the long put option’s strike price.
Are protective puts bullish or bearish?
Investors use a protective put when they want to limit downside risk of a long equity position. The investor is bullish on the underlying stock and uses the long put to hedge potential losses.
Are protective puts worth it?
Protective puts limit a stock’s downside and hedge against downside risk. However, buying a protective put adds cost to the original stock position and increases the trade’s cost basis, so it is important to factor in those considerations when thinking of using a protective put.
What is a an example of a protective put?
If you own a stock at $100 per share, you could buy a protective put with a strike price of $95. If you pay $5.00 for the put option, the maximum risk for the position is $1000 per contract ($95 strike price – $100 cost basis – $5 option premium = -$10 (x 100 shares per contract) = -$1,000).

Bull Put Spread

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Bull Put Credit Spread overview

Bull put spreads, also known as short put spreads, are credit spreads that consist of selling a put option and purchasing a put option at a lower price. The strategy looks to take advantage of an increase in price in the underlying asset before expiration. Time decay and decreased implied volatility will also benefit the bull put credit spread.

Bull Put Credit Spread market outlook

A bull put credit spread is entered when the seller believes the price of the underlying asset will be above the short put option’s strike price on or before the expiration date. Bull put spreads are also known as put credit spreads because they collect a credit when the trade is entered. The risk is limited to the width of the spread minus the credit received. The break-even price for the bull put credit spread is the short strike price minus the net credit received. Time decay and decreased implied volatility will also help the position become profitable. The closer the short strike price is to the underlying’s price, the more credit will be received at trade entry.

How to set up a Bull Put Credit Spread

A bull put credit spread is made up of a short put option with a long put option purchased at a lower strike price. The credit received is the maximum potential profit for the trade. The maximum risk is the width of the spread minus the credit received. The closer the strike prices are to the underlying’s price, the more credit will be collected, but the probability is higher that the option will finish in-the-money. The larger the width of the spread between the short option and the long option, the more premium will be collected. The outlook is more aggressive and the maximum risk will be higher.

Bull Put Credit Spread payoff diagram

The bull put credit spread payoff diagram clearly outlines the defined risk and reward of credit spreads. Bull put spreads collect a credit when entered. The credit received is the maximum potential profit for the trade. Because long options are purchased for protection, the maximum risk is limited to the width of the spread minus the credit received.

For example, if a $5 wide bull put spread collects $1.00 of credit, the maximum gain is $100 if the stock price is above the short put at expiration. The maximum loss is $400 if the stock price is below the long put at expiration. The break-even point would be the short put strike minus the premium received.

Bull Put Spread Strategy

Image of bull put spread payoff diagram showing max profit, max loss, and break-even points

Entering a Bull Put Credit Spread

A bull put spread consists of selling-to-open (STO) a put option and buying-to-open (BTO) a put option at a lower strike price, with the same expiration date. This will result in a credit received. Buying the lower put option will reduce the overall premium collected to enter the trade but will define the position’s risk to the width of the spread minus the credit received.

For example, if an investor believes a stock will be above $50 at expiration, they could sell a $50 put option and buy a $45 put option. If this results in a $1.00 credit, the maximum profit potential is $100 if the stock closes above $50 at expiration, and the maximum loss is $400 if the stock closes below $45 at expiration.

  • Sell-to-open: $50 put
  • Buy-to-open: $45 put

The closer to the underlying stock price the spread is sold, the more bullish the bias.

Exiting a Bull Put Credit Spread

A bull put credit spread is exited by buying-to-close (BTC) the short put option and selling-to-close (STC) the long put option. If the spread is purchased for less than it was sold, a profit will be realized. If the stock price is above the short put option at expiration, both options will expire worthless, and the entire credit will be realized as profit. If the stock price is below the long put option at expiration, the two contracts will offset, and the position will be closed for the maximum loss.

For example, if a bull put credit spread is opened with a $50 short put and a $45 long put, and the underlying stock price is below $45 at expiration, the broker will automatically buy shares at $50 and sell shares at $45. If the stock price is between the two put options at expiration, the short option will be in-the-money and need to be repurchased to avoid assignment.

Time decay impact on a Bull Put Credit Spread

Time decay, or theta, works in the advantage of the bull put credit spread strategy. Every day the time value of an options contract decreases. Theta will exponentially lose value as the options approach expiration. The decline in value may allow the investor to purchase the options for less money than initially sold, even if a significant rise in price does not occur.

Implied volatility impact on a Bull Put Credit Spread

Bull put credit spreads benefit from a decrease in the value of implied volatility. Lower implied volatility results in lower option premium prices. Ideally, when a bull put credit spread is initiated, implied volatility is higher than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Bull Put Credit Spread

Bull put spreads can be adjusted if the underlying stock price has moved down and the position is challenged. An investor has two choices to maximize the probability of success as the position approaches expiration. 

If the stock price has decreased, an opposing bear call credit spread can be opened above the put spread to create an iron condor. Additional credit will be received and no additional risk will be added to the position if the spread width and number of contracts remain the same.

For example, if a $55 / $60 call credit spread is added to the original position and collects $1.00 of premium, the break-even point will be extended down and give the position a higher probability of profit while reducing risk. However, if the stock reverses, the bear call spread could become challenged.

  • Sell-to-open: $55 call
  • Buy-to-open: $60 call
Bull Put Spread Strategy

Image of a bull put spread adjusted to an iron condor

If the stock price has decreased substantially and the short option is in-the-money, an opposing bear call credit spread may be opened with the same strike price and expiration date as the put spread. This will create an iron butterfly. Additional credit will be received and no additional risk will be added to the position if the spread width and number of contracts remain the same. A credit spread adjusted to an iron butterfly will have more profit potential and less risk than an iron condor, but the position’s range of profitability ($47 – $53) is smaller than an iron condor.

For example, if a call credit spread centered at the same $50 strike price collects an additional $2.00 of credit, the break-even point will be extended down and give the position a higher probability of profit while reducing risk. However, if the stock reverses, the bear call spread could become challenged.

  • Sell-to-open: $50 call
  • Buy-to-open: $55 call
Bull Put Spread Strategy

Image of a bull put spread adjusted to an iron butterfly

Rolling a Bull Put Credit Spread

Bull put spreads can be rolled out to a later expiration date to extend the duration of the trade. Rolling the position for a credit reduces risk and extends the break-even point. To roll the position, purchase the existing bull put credit spread and sell a new spread with a later expiration date. 

For example, if the original bull put spread has a June expiration date and received $1.00 of premium, an investor could buy-to-close (BTC) the entire spread and sell-to-open (STO) a new position with the same strikes in July. If this results in a $1.00 credit, the maximum profit potential increases by $100 per contract and the maximum loss decreases by $100 per contract. The new break-even price will be $48.

Bull Put Spread Strategy

Image of a bull put spread roll out to later expiration date for credit

Hedging a Bull Put Credit Spread

Bull put credit spreads can be hedged to help minimize the position’s risk while increasing profit potential. If the stock price has moved down, an opposing bear call credit spread can be opened with the same spread width and expiration date as the bull put spread. This brings in additional credit while reducing the maximum risk. The new spread helps to offset the loss of the original position.

FAQs

Are short put spreads bullish or bearish?
Short put spreads are a bullish options strategy. You will profit if the underlying stock’s price is above the short put’s strike price at expiration.
What is the difference between a short put and a bull put spread?
A short put is a single-leg bullish options strategy with undefined risk and limited profit potential. A bull put spread (or short put spread) is also bullish, but has defined risk and limited profit potential. Bull put spreads consist of selling a short put and buying a long put at a lower strike price.
What is the difference between a short put spread and a long put spread?
Short put spreads (also known as credit spreads) are a bullish options strategy. You sell a short spread and receive a credit. The credit received is the max profit for the position. The maximum risk is the width of the spread minus the credit received.

Long put spreads are bearish. You buy long put spreads (also known as a debit spread), and the premium paid is the max loss for the position. The maximum profit potential is the width of the spread minus the debit paid.
What is the max loss for a bull put spread?
Bull put spreads collect a credit when entered. The maximum risk is the width of the spread minus the credit received. The credit received is the maximum potential profit for the trade.

For example, if you sell a $3 wide bull put spread for $1.75, the position’s max loss is -$225.

Bull Call Spread

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Bull Call Debit Spread overview

Bull call spreads, also known as long call spreads, are debit spreads that consist of buying a call option and selling a call option at a higher price. The strategy looks to take advantage of a price increase from the underlying asset before expiration. Increased implied volatility may also benefit the bull call debit spread.

Bull Call Debit Spread market outlook

A bull call debit spread is entered when the buyer believes the underlying asset price will increase before the expiration date. Bull call spreads are also known as call debit spreads because they require paying a debit at trade entry. Risk is limited to the debit paid at entry. The further out-of-the-money the bull call debit spread is initiated, the more aggressive the outlook.

How to set up a Bull Call Debit Spread

A bull call debit spread is made up of a long call option with a short call option sold at a higher strike price. The debit paid is the maximum risk for the trade. The maximum profit potential is the spread width minus the premium paid. To break even on the position, the stock price must be above the long call option by at least the cost to enter the position.

The closer the strike prices are to the underlying’s price, the more debit will be paid, but the probability is higher that the option will finish in-the-money. The larger the spread width between the long call and the short short, the more premium will be paid, and the maximum potential profit will be higher.

Bull Call Debit Spread payoff diagram

The bull call spread payoff diagram clearly outlines the defined risk and reward of debit spreads. Bull call spreads require a debit when entered. The debit paid is the maximum potential loss for the trade. Because a short option is sold to reduce the trade’s cost basis, the maximum profit potential is limited to the spread width minus the debit paid.

For example, if a $5 wide bull call debit spread costs $2.00, the maximum profit is $300 if the stock price is above the short call at expiration, and the maximum loss is $200 if the stock price is below the long call at expiration. The break-even point would be the long call strike plus the premium paid.

Bull Call Spread Strategy

Image of bull call spread payoff diagram showing max profit, max loss, and break-even points

Entering a Bull Call Debit Spread

A bull call spread consists of buying-to-open (BTO) a call option and selling-to-open (STO) a call option at a higher strike price, with the same expiration date. This will result in paying a debit. Selling the higher call option will help reduce the overall cost to enter the trade and define the risk while limiting the profit potential.

For example, an investor could buy a $50 call option and sell a $55 call option. If the spread costs $2.00, the maximum loss possible is -$200 if the stock closes below $50 at expiration. The maximum profit is $300 if the stock closes above $55 at expiration. The break-even point would be $52.

  • Buy-to-open: $50 call
  • Sell-to-open: $55 call

Bull call debit spreads can be entered at any strike price relative to the underlying asset. In-the-money options will be more expensive than out-of-the-money options. The further out-of-the-money the spread is purchased, the more bullish the bias.

Exiting a Bull Call Debit Spread

A bull call spread is exited by selling-to-close (STC) the long call option and buying-to-close (BTC) the short call option. If the spread is sold for more than it was purchased, a profit will be realized. If the stock price is above the short call option at expiration, the two contracts will offset, and the position will be closed for a full profit.

For example, if a call debit spread is opened with a $50 long call and a $55 short call, and the underlying stock price is above $55 at expiration, the broker will automatically buy shares at $50 and sell shares at $55. If the stock price is below the long call option at expiration, both options will expire worthless, and the full loss of the original debit paid will be realized.

Time decay impact on a Bull Call Debit Spread

Time decay, or theta, works against the bull call debit spread. The time value of the long option contract decreases exponentially every day. Ideally, a large move up in the underlying stock price occurs quickly, and an investor can capitalize on all the remaining extrinsic time value by exiting the position.

Implied volatility impact on a Bull Call Debit Spread

Bull call debit spreads benefit from an increase in the value of implied volatility. Higher implied volatility results in higher options premium prices. Ideally, when a bull call debit spread is initiated, implied volatility is lower than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Bull Call Debit Spread

Bull call debit spreads have a finite amount of time to be profitable and have multiple factors working against their success. If the underlying stock does not move far enough, fast enough, or volatility decreases, the spread will lose value rapidly and result in a loss. Bull call spreads can be adjusted like most options strategies but will almost always come at more cost and, therefore, add risk to the trade and extend the break-even point.

If the stock price has moved down, a bear put debit spread could be added at the same strike price and expiration as the bull call spread. This creates a reverse iron butterfly and allows the put spread to profit if the underlying price continues to decrease. However, the additional debit spread will cost money and extend the break-even point.

For example, if a $5 wide put debit spread centered at the same $50 strike price costs $1.00, an additional $100 of risk is added to the trade, and the profit potential decreases by $100.

  • Buy-to-open: $50 put
  • Sell-to-open: $45 put
Bull Call Spread Strategy

Image of a bull call spread adjusted into an reverse iron butterfly

Rolling a Bull Call Debit Spread

Bull call debit spreads can be rolled out to a later expiration date if the underlying stock price has not moved enough. To roll the position, sell the existing bull call spread and purchase a new spread at a later expiration date. This requires paying another debit and will increase the risk, but will extend the duration of the trade.

For example, if the original bull call spread has a March expiration date and cost $2.00, an investor could sell-to-close (STC) the entire spread and buy-to-open (BTO) a new position in April. If this results in a $1.00 debit, the maximum profit potential decreases by $100 per contract and the maximum loss increases by $100 per contract. The new break-even price will be $53.

Bull Call Spread Strategy

Bull call spread rolled to a later expiration date for a debit

Hedging a Bull Call Debit Spread

Bull call debit spreads can be hedged if the underlying stock’s price has decreased. To hedge the bull call spread, purchase a bear put debit spread at the same strike price and expiration as the bull call spread. This would create a long butterfly and allow the position to profit if the underlying price continues to decline. The additional debit spread will cost money and extend the break-even points.

FAQs

What is a bull debit spread?
A bull debit spread is a bullish strategy with limited profit potential and defined risk. The strategy consists of buying a call option and selling a call option with the same expiration date at a higher strike price.
Is a call debit spread bullish or bearish?
Call debit spreads are bullish and also known as bull call spreads. Call debit spreads benefit when the underlying security’s price increases.
What is an example of a call debit spread?
A bull call spread consists of buying-to-open (BTO) a call option and selling-to-open (STO) a call option at a higher strike price, with the same expiration date. This will result in paying a debit. Selling the higher call option will help reduce the overall cost to enter the trade and define the risk while limiting the profit potential.

For example, an investor could buy a $50 call option and sell a $55 call option. If the spread costs $2.00, the maximum loss possible is -$200 if the stock closes below $50 at expiration. The maximum profit is $300 if the stock closes above $55 at expiration. The break-even point would be $52.
Are debit spreads risky?
Call debit spreads and put debit spreads have defined risk. The premium paid to open the position is the max potential loss. To realize a max loss, the underlying price must be below the long call option at expiration.

Profit potential is limited for debit spreads. A bull debit spread’s max profit is the spread’s width minus the premium paid. To realize the max profit, the underlying price must be above the short call option at expiration.