Option spreads are the basic building blocks of many options trading strategies. A spread position is entered by buying and selling equal number of options of the same class on the same underlying security but with different strike prices and/or expiration dates.
Any spreads that are constructed using calls can be referred to as a call spread. Similarly, put spreads are spreads created using put options.
There are basically three classes of spreads:
- Vertical spreads
- Horizontal or calendar spreads
- Diagonal spreads
A vertical spread is constructed using options of the same class, same underlying security, same expiration month, but at different strike prices. Horizontal or calendar spreads are constructed using options of the same underlying security, same strike price but with different expiration dates. Diagonal spreads are created using options of the same underlying security but different strike prices and expiration dates.
Option spreads can also be classified as Bull & Bear spreads. If an option spread is designed to profit from a rise in the price of the underlying security, it is a bull spread. Conversely if an option spread is designed to profit from fall in the price of underlying security, it is a bear spread.