Buying the Call Vertical Spread = Selling the Put Vertical Spread

The Dow has just had three triple digit up days in a row. If it does that today it will be the first time there were 4 100+ point days since.... Never! The Dow has never been up triple digits 4 days in a row. Can we say overbought?

However, market prognostication is not my thing. Options education is, so off we go:

I do not like buying or selling options outright. I prefer hedging risk by trading in the form of a spread. And today we will look at vertical spreads. A vertical spread means being long one option and short one in the same month, hence vertical. If I buy the XYZ 90 call at 5 and sell the 100 call at 1 the most I can lose if both options expire worthless is 4 and the most I can make if both options expire in the money is 6. So, it is a bullish trade that we put on for a 4 point debit.

Think about this: What if I sell the vertical put spread at 6? Buy the 90 put at 2 and sell the 100 put at 8, for instance, making for a 6 point credit. Again, the most I can make is 6 and the most I can lose is 4. The risk/reward ratio is exactly the same and both are bullish trades. Given identical risk profiles I would prefer doing a spread for a credit that puts money into my account as opposed to a debit spread that takes money out of my account.

Let's look at the relationship between the 90-100 call spread and the 90-100 put spread. Where ever our mythical stock XYZ ends on expiration the combination of the two vertical spreads will be 10. An expiration above 100 means the call spread goes out at 10 and the put spread at 0. An expiration below 90 means the put spread goes out 10 and the call spread at 0. An expiration price of 95 means both spreads go out at 5, and so on. The combination of the call vertical and the put vertical is called the Box and we'll look more closely at that another time.

The lesson to take away today is this: Let's say I sold that put spread at 6 and the stock goes my way, ie moves higher and the put spread narrows to 4. I can unwind, buy back, the spread at 4 for a 2 point profit. But, I can also sell the call spread at 6 (if the put spread is 4 the call spread must be 6, for reasons outlined above). I have then sold the combination of both spreads (the Box) at 12 and this combination will expire at 10 regardless of where XYZ is on expiration. So, I have locked in the same 2 point profit but I now have 12 points of cash in my account until expiration, which will collect interest, however modest.

In conclusion, selling the vertical put spread equals buying the vertical call spread and vice versa. If you know the price of one spread then you also know the price of the other spread. And who said options were complicated?