Option Strategies
How does Implied Volatility affect Vertical Spreads?
Understanding your potential profits and losses depends on understanding implied volatility
- Implied volatility measures how much extrinsic value is being priced into a stock’s options
- Higher IV translates into a greater Extrinsic Value
- Lower IV translates into a lower Extrinsic Value
- A vertical spread can only reach max profit if the EV reaches zero
- Since vertical spreads require a decrese in EV to reach maximum profit potential, you want IV to decrease as the stock price is moving IN your favor.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread:
- premium paid
- The potential loss will always be known before you get into a trade.
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions.
Example:
If the strike prices is 5.00 (105.00 – 100.00 = 5.00), and the net credit is 1.80 (3.30 – 1.50 = 1.80).
The maximum risk, therefore, is 3.20 (5.00 – 1.80 = 3.20) per share less commissions.
This maximum risk is realized if the stock price is at or above the strike price of the long call at expiration.
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
Vertical ( Bull ) Call Spread:
- Strike price of short call (lower strike) plus net premium received.
- In this example: 100.00 + 1.80 = 101.80
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
When you BUY a vertical spread, what do you want IV to change over time?
If the Stock price is moving in your favor :
- An increase in IV is less profitable
- An increase in IV will decrease the value of your option
If the Stock price is moving against you:
- A flat IV ( no change in IV ) is more profitable
- An increase in IV will be more profitable
When you BUY a vertical spread, and the price is moving in your favor, what do you want IV to do?
- You will want IV to decrease
- A fall an IV as a stock moves in your favor will increase your profits
- A decrease in IV will decrease the extrinsic value faster
When you BUY a vertical spread, and the price is moving against you, what do you want IV to do?
- You will want IV to increase or stay flat
- An increase in IV when the stock price is moving against you will lessen losses
- An increase in IV will increase the extrinsic value
