A vertical spread involves a simultaneous long and short options position, where the short option is placed closer to ATM, and the long option is placed further OTM. Vertical credit spreads offer an options trader an opportunity to position themselves to sell premium as the short side of an options contract, while at the same time defining their risk on order entry. Short call spreads would be used for bearish assumptions, and short put spreads would be used for bullish assumptions. A great explanation of vertical debit spreads can be found right here.
The strike on the long option that is further OTM is where all of your risk is defined. If prices move above your long call strike in a short call spread, your gains from your long call and your losses from your short call effectively cancel each other out. If prices move below your long put in a short put spread, your gains from your long put and your losses from your short put effectively cancel each other out. Thus, your maximum loss is defined as the difference between your strike prices minus the credit you received, when the trade was initiated.
Vertical spreads are great strategies for a beginning options trader because they offer you the opportunity to learn about selling premium, while controlling exactly how much risk you want to take. Just remember to always look at a vertical spread as a package, rather than trying to take off the individual legs.
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