Options Jive

Vertical Spreads | Which Strikes Should I Use?

| Apr 5, 2016
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    Options Jive

    Vertical Spreads | Which Strikes Should I Use?

    Apr 5, 2016

    When do we look to buy a vertical spread versus selling a vertical spread? Which strikes do we use and how can we generate positive Theta (time decay) on a debit spread position?

    Our probability of profit (POP) on a trade is known at order entry when we choose our strikes. A vertical spread is formed by placing a long and short option of the same type (calls or puts) in the same underlying and expiration.

    A long position in the lower strike will always be bullish and being long the higher strike is always bearish. Implied volatility (IV) tells us to either use a credit spread or a debit spread. When IV is high (with an IVR above 50) we use a credit spread, and when IV is low (IVR below 50) we use a debit spread.

    When establishing a credit spread the delta of the short strike, the width of the spread and our credit tells us the probability of profit. We want to choose our long strike so that the price we sell the spread for is ⅓ or more of the width of the strikes.

    When establishing a debit spread we want to choose a long strike that is in-the-money (ITM) and a short strike that is out-of-the-money (OTM). When the long strike has more intrinsic value than the price we paid for the spread we have positive Theta. We do not want to pay more for the spread than the intrinsic worth of our long strike because not only do we have negative Theta but our POP will be lower. A spread with negative Theta always has a lower POP than one with positive Theta.

    For more on Vertical Spreads you can watch these segments:

    Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the important takeaways and to know more about vertical spreads so you can give yourself the best possible chance of success.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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