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Generate Income Trade Options
Option spreads are trading strategies involving taking both sides of an option trade, but in such a way as to achieve an overall lower risk / reward ratio than standard, outright option purchases. Generally, there are two types of spreads, Horizontal and Vertical. Horizontal means that we pick 2 option contracts, on the same stock, these 2 options have the same strike price, but they have different expiry terms. Horizontal, refers to the time axis on the charts, which is the horizontal axis, hence the name horizontal spreads. They always have to do with options that are similar in everything else but differ in expiry dates. Vertical spreads on the other hand are just the opposite, the option contracts always have the same expiry terms, but they do differ in strike prices. There are the Diagonal spreads too, where both contract terms and strike prices are different, as we shall see in another article about diagonal spreads.
The implication of different strike prices is a different Delta, and the implication of different expiry terms is a different Theta.
The idea is that the trader has to take both sides of the trade, by buying one option and selling the other, remember that the two options will differ either vertically or horizontally! In sophisticated software platforms such as at the ones found at Analyzetrade.com, you will see the term ‘leg’, this simply means option trade.
And most option spreads have 2 option trades (or 2 legs), hence you have to use choice 2 ‘leg’ when simulating option spreads. It is of course possible to use 3 legs too, in more sophisticated spreads and trading strategies, and the software allows this! It combines all trades and works out accurately, the profit/loss curve for any kind of market scenario and option criteria you choose. Overlooked profit opportunities would have been impossible to detect otherwise, simply because the nature and complexity of the 3 leg strategies are too difficult for direct human observation using pen and paper.
The software used at CBOE, brokers’ software, as well as the software tools used at Anlayzetrade.com have been developed by former NASA engineers qualified in mathematics, control systems and other relevant fields. The first task that these engineers had to do, was to develop a software algorithm that will measure everything and will protect the broker from market risk, as well as to detect arbitrage trades and eliminate them. But that’s about it, the system was designed to offer a fair, liquid market for everyone, and protect the brokers. This doesn’t mean that the system knows everything and that there’s no overlooked, profitable, and even risk-free opportunities hidden in all this complexity.
In fact, even arbitrage opportunities still exist in the options market, and this is proof that either the global option market system is not perfect, or they just don’t care much about ‘minor’ arbitrage opportunities. As far as I know, arbitrage opportunities are closely watched in the forex market and the big banks use computers that automatically trade and remove this arbitrage thing, if and when it shows up. But in the broader options market, there are still many arbitrage opportunities, and of course many, many more, very low risk and huge reward opportunities that are just as hard to detect.
Traders often use spread strategies to exploit overlooked opportunities in the markets, or just to achieve a better trade than a classic outright option trade.
They overall offer, a better trade, that is slightly less profit, but much less risk. Option spreads are complex and hard to figure out at once, but they are the best of trading strategies.
Common option spreads are the Bull and Bear Call/Put spreads, Calendar spreads, Butterfly spreads, Collar spreads, and more. But these are just the general ideas, there are many more variant strategies of these ideas. There are advanced spread strategies that are based on arbitrage, and they make small risk free money, all the time! As well as extremely low risk / huge reward spreads that we don’t even know about. Floor traders use all of these techniques.
Generally, one cannot fully take advantage of options trading, up until they start using their own variant of an options spread trading idea. One that suits their trading needs in the best way possible. The best way to investigate the markets and experiment with your own, unique option spread strategy, is to use advanced back testing and trade simulation tools, such as the ones offered at Analyzetrade.com, up to 3 leg spreads can be tested in detail!
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