Now, with vertical spreads, we are working with more than one option. A vertical call debit spreads is the purchase of a call at a price lower than the current price (ITM) and the sale of a call at price lower than the current price (OTM). The key to vertical spreads, in that the purchase and sale of the option is simultaneous, meaning that the ITM and OTM assumptions are relative to the same market price.
To visualize the spread, let's revisit the graphs for buying and selling call options:
From the graph we can easily interpret, that with a vertical call debit spread, we want the price to be at or above the original market price price. The strategy is also called the bull call spread, as "bull" implies our directional assumption about the trade.
Profit: The maximum profit we can obtain from this trade is equivalent to the difference between the ITM and OTM prices, we bought or sold a call at (respectively) and the premium. In the above graph, we can tell that the trader bought an ITM call @ $40.00 and sold an OTM call @ $45.00. Because options contracts are linked to 100 units of stock, the difference between these two prices is $5.00 x 100= $500. The premium, or $200, is subtracted from this difference to calculate the maximum profit of $300.
Loss: Unlike the sale of a naked call option, the vertical call spread has a maximum loss of the amount paid for the premium of buying the ITM call.
Eighteen-year old trader, future connoisseur of options.
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