8.4 Spreads and Combinations
Key Takeaways
- Spreads use two options of the same type (both calls or both puts) to define risk.
- Debit spreads pay net premium and want the underlying to move toward the strikes.
- Credit spreads receive net premium and want the underlying to stay put.
- Straddles use one strike; strangles use two OTM strikes — both are volatility plays.
- Long straddle/strangle profit from big moves; short versions profit from stability.
What a Spread Is
A spread is the simultaneous purchase and sale of two options of the same type (both calls or both puts) on the same underlying, differing in strike, expiration, or both. Spreads cap both profit and loss, giving defined risk, which is why conservative directional traders favor them over naked positions.
Debit vs. Credit
| Type | Net premium | Wants the stock to... | Max gain | Max loss |
|---|---|---|---|---|
| Debit spread | Pay (buy the costlier option) | Move (toward the strikes) | Strike difference − net debit | Net debit |
| Credit spread | Receive (sell the costlier option) | Stay (away from the strikes) | Net credit | Strike difference − net credit |
Memory tip: In a debit spread you want the spread to widen; in a credit spread you want it to narrow to zero so you keep the credit.
Bull Call Spread (Debit, Moderately Bullish)
Buy the lower-strike call, sell the higher-strike call.
Buy 1 XYZ 50 call @ $5, sell 1 XYZ 55 call @ $2 → net debit $3:
| Item | Formula | Result |
|---|---|---|
| Max gain | (Higher − lower strike) − net debit | ($55 − $50) − $3 = $200 |
| Max loss | Net debit | $3 x 100 = $300 |
| Breakeven | Lower strike + net debit | $50 + $3 = $53 |
Bear Put Spread (Debit, Moderately Bearish)
Buy the higher-strike put, sell the lower-strike put.
Buy 1 XYZ 55 put @ $5, sell 1 XYZ 50 put @ $2 → net debit $3:
| Item | Formula | Result |
|---|---|---|
| Max gain | (Higher − lower strike) − net debit | ($55 − $50) − $3 = $200 |
| Max loss | Net debit | $3 x 100 = $300 |
| Breakeven | Higher strike − net debit | $55 − $3 = $52 |
Credit Spreads
- Bull put spread (moderately bullish): sell the higher-strike put, buy the lower-strike put. Max gain = net credit; max loss = strike difference − net credit.
- Bear call spread (moderately bearish): sell the lower-strike call, buy the higher-strike call. Same max-gain/max-loss formulas.
Exam alert: Identify the spread by the option you buy at the more expensive strike. If you pay net premium it is a debit spread; if you receive net premium it is a credit spread. The dominant (net long or net short) leg sets the directional bias.
Straddles — Same Strike, Same Expiration
A straddle is a call and a put with the same strike and expiration. It is a pure volatility bet — direction does not matter, magnitude does.
Long Straddle (expect a big move)
Buy 1 XYZ 50 call @ $3 and buy 1 XYZ 50 put @ $2 → total premium $5:
| Item | Detail |
|---|---|
| Market view | High volatility (big move either way) |
| Max gain | Unlimited (upside) or strike − premium (downside) |
| Max loss | Total premium = $500 |
| Breakevens | $50 + $5 = $55 and $50 − $5 = $45 |
The stock must move beyond $55 or below $45 to profit — it must overcome both premiums.
Short Straddle (expect stability)
Sell 1 XYZ 50 call @ $3 and sell 1 XYZ 50 put @ $2 → collect $5:
| Item | Detail |
|---|---|
| Market view | Low volatility (stock pins near strike) |
| Max gain | Total premium = $500 |
| Max loss | Unlimited (call side) |
| Breakevens | $55 and $45 |
Strangles — Two OTM Strikes
A strangle uses different strikes, usually both out-of-the-money, lowering cost but widening the breakeven band.
Long strangle — buy 1 XYZ 55 call @ $2 and buy 1 XYZ 45 put @ $1 → total $3:
| Item | Detail |
|---|---|
| Market view | High volatility |
| Max loss | Total premium = $300 |
| Breakevens | $55 + $3 = $58 and $45 − $3 = $42 |
| Cost | Cheaper than a straddle because both legs are OTM |
Spread Categories
| Spread | Strikes | Expirations | Purpose |
|---|---|---|---|
| Vertical | Different | Same | Directional, defined risk |
| Horizontal (calendar) | Same | Different | Time-decay play, neutral |
| Diagonal | Different | Different | Combination of both |
Strategy-to-View Quick Map
| Outlook | Strategy |
|---|---|
| Strongly bullish | Long call |
| Moderately bullish | Bull call (debit) or bull put (credit) spread |
| Big move expected (either way) | Long straddle or long strangle |
| Stable/quiet market | Short straddle or short strangle |
| Moderately bearish | Bear put (debit) or bear call (credit) spread |
| Strongly bearish | Long put |
Common trap: A long straddle profits from volatility, not direction — the exam will offer "bullish" or "bearish" distractors. The strangle is always cheaper than the straddle but needs a larger move to break even.
An investor executes a bull call spread by buying an ABC 40 call for $5 and selling an ABC 45 call for $2. What is the maximum gain?
An investor buys a straddle with an XYZ 50 call @ $4 and an XYZ 50 put @ $3. What are the breakeven points?
Which strategy profits most when a stock remains stable with low volatility?