OpenMarkets Weekly: Options Spreading

Leading up to the launch of Micro E-mini options, I've been reviewing the basics of options markets. In the past two episodes, I've focused on the terminology of options. In the video above, I take a look at spreading one option against another as a key strategy in the options marketplace.

We'll concentrate on four basic spreads: a bull spread, a bear spread, a strangle and a straddle.

Bull Spread

When placing a bull spread position, the trader simultaneously buys calls at a specific strike price while also selling the same number of calls at a higher strike price. Both call options will have the same expiration date and underlying asset.

Using this strategy, the investor is reducing the net premium spent as opposed to buying a naked call option outright. The trade-off of a bull call spread is that your upside is limited along with your risk. Using a hypothetical example, with the S&P 500 futures trading at 3300, buying the 3300 call and selling the 3500 call would be an example of a bull spread.

Bear Spread

A bear spread is when the investor simultaneously purchases put options at a specific strike price and also sells the same number of puts at a lower strike price. This strategy is used when the trader is bearish the market and expects the price to decline.

Just like a bull spread, the strategy offers both limited losses and limited gains. An example would be, with S&P's at the 3300 level, buying the 3300 put and selling the 3100 put.

Straddle

A straddle options strategy occurs when the trader simultaneously buys a call and put option on the same underlying market with the same strike price and expiration date. The trader will often use this strategy when they believe the price of the market will move significantly out of a specific range, but they are unsure of which direction the move will take.

Again, with our hypothetical S&P futures trading at 3300, buying the 3300 call and buying the 3300 put is an example of a straddle.

Strangle

Finally, a strangle options strategy is when the trader purchases an out-of-the-money call option and an out-of-the-money put option simultaneously on the same market with the same expiration date. The trader who uses this strategy believes the market's price will go through a large move but unsure of the direction. Strangles are less expensive than straddles because the options purchased are out-of-the-money.

Using the previous example, with the S&P 500 at 3300 a strangle would be buying a 3000 put and a 3600 call. Both out of the money.

These are only four basic spreads. There are thousands of strategies one can take in the options market. However, getting a firm grasp of options spreading can give active traders an opportunity to incorporate a Micro E-mini options strategy into their trading and investing.

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To learn more about futures and options, go to Benzinga’s futures and options education resource