SPREADS

Vertical spreads

A vertical spread consists of equal units of long and short options at different
strikes. If the long strike is lower than the short strike, it is considered a bullish
vertical. If the long strike is higher than the short strike, it is a bearish vertical.

The key aspects of the vertical trade are 1) directionality (the trade maintains a
correlation and sensitivity to price movement) and 2) regional leverage.


Butterfly 

A butterfly consists of a long vertical and short vertical spread with the long
strikes outside (above and below) the short strikes. Typical “fly” has two short
units at the same strike. Example: +1 50C/-2 55C/+1 60C.

The key aspects of the butterfly are 1) fixed risk and 2) neutrality over a price zone (in Greek terminology, “theta positive”).


Ratio spreads

Ratio spreads are simply verticals with at least one additional short unit. The
most common form is a one by two spread such as +1 50C/-2 55C. Ratio trades
are the ultimate defense against a losing position. The key aspects of ratio
spreads are 1) cost reduction and 2) risk displacement.