Vertical Spreads Explained

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Vertical Option Spreads – Vertical Option Spreads 101

This article originally appeared on The Options Insider Web site.

Editor’s note: This is the first of a five-part series on vertical spreads. This article will introduce the concept of the vertical spread and define its four main components, while the next four articles will deal with individual vertical spread strategies.

A vertical spread is a trade in which the simultaneous buying and selling of the same class option (i.e., either puts or calls, but not both together) is performed on the same underlying stock. Verticals must be done on the same expiration month, and they involve the selection of different strike prices.

The table below visually represents the four components mentioned above:

The first three categories (underlying, option class and month of expiry) are easy to comprehend. The buying and selling is done on the same underlying. Either calls or puts are used (not a mix of both). Moreover, the action of buying a put and selling a put (or buying a call and selling a call) is done using the same expiry month. So there is not much variation: same underlying, same option class (calls or puts), and same expiry month. So there is not much variation: same underlying, same option class (calls or puts), and same expiry month.

However, traders love choices, and options on equities are simply just that: choices. One of my students asked what would happen if we buy a call and sell a put at the same strike price on the same underlying and on the same month.

The figure below uses the same four components that were used to describe the basics of verticals, yet two components are changed (the bold ones).

Two components from the vertical spread have reversed their places: The option class is now different and the strike prices are now the same. If a trader buys an at-the-money (ATM) call and sells an ATM put, then the trader has traded the same strike prices using two different option classes. This strategy is known as a synthetic long.

There is also another variation, which would still have the same strike prices and different option classes but an ATM put is bought and an ATM call is sold. This strategy is a synthetic short. These are NOT vertical spreads.

The bottom line is that changing any of these four components would create a completely new option strategy.

Therefore, for simplicity’s sake, I will stay on the topic of verticals and will not change any of the first three components: underlying, option class and month of expiry. I am covering only verticals and my primary focus is on the fourth component, strike prices.

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Here is the earlier table:

When a variation is done by selection of different strike prices on the same underlying, with the same option class and the same month of expiry, then the trader still ends up with more than one choice. However, the starting point should be looking at what is first bought.

For instance, the verticals could be done in such a way that first, an ATM strike price is purchased. Once the purchase is completed, then the next leg could be opened. The trader could choose to sell either one strike price above the bought ATM option, or sell one strike price below the bought ATM option. If the situation is done in such way that the sold option brings more premium in than what was paid out for the bought option, then that is called a vertical credit spread.

If it is the other way around, meaning that more premium was paid out and only part of it was received back for the sold option, then that is called a vertical debit spread.

What makes the verticals even more complex is that the same thing can be done with calls as well as with puts.

The table below visually represents four possible choices. Due to the scope of this article, I will address each of these four in subsequent articles.

In conclusion, the aim of this article was to simply introduce the concept of the vertical spread and to define its four components. A change of any of the four components creates a completely new strategy, yet within each new strategy there could be variations as was explained when verticals were compared to synthetics, which, in turn, could be either long or short synthetics.

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Defining Vertical Spreads

One of the main ways for classifying options spreads is based on the position of the options involved in the spread relative to each other. There are three different types of directional options spreads – vertical, horizontal and diagonal.

A vertical spread is where the options involved appear vertically stacked on an options chain, hence the name. There are a number of different types of vertical spreads, which can be used in a range of trading strategies. On this page we explain them in more detail, covering the following topics:

  • How They are Created
  • Example of a Vertical Spread
  • Types of Vertical Spreads and Their Uses

You should appreciate that this page was written with a view to primarily defining vertical spreads with an overview of how they can be used in options trading. Like all the other types, vertical spreads and their various forms are essentially options trading strategies in their own right. For a more complete understanding of utilizing them effectively, we would strongly recommend reading our section on Options Trading Strategies.

How Vertical Spreads Are Created

Creating a vertical spread is basically very simple. You can create one by buying options contracts, using the buy to open order, and selling contracts, using the sell to open order. The contracts must be of the same type, have the same expiration date and be based on the same underlying security but have different strike prices. They can be either debit spreads which incur an upfront cost, or credit spreads which would give you an upfront credit.

The options contracts involved in creating a vertical spread appear vertically stacked when looking at them on an options chain. If you are not familiar with what options chains are and they work, then please read our article on them, which explains how they are used to display information regarding options contracts and their prices.

Example of a Vertical Spread

An example of a vertical spread would be as follows. You use a buy to open order to buy 100 of the following options contracts:

  • Call
  • Based on stock in Company X
  • Company X stock currently trading at $50
  • Expiration Date of August 2020
  • Strike Price of $49
  • Ask Price of $2

You then use a sell to open order to write 100 of the following contracts:

  • Call
  • Based on stock in Company X
  • Company X stock currently trading at $50
  • Expiration Date of August 2020
  • Strike Price of $52
  • Bid Price of $.70

By buying calls at one strike price, and writing calls on the same underlying security with a different strike price you have created a vertical spread. You could also do the same with puts too. In this example you have created a debit spread, as you have spent more on the options contracts you have bought than you have recouped on the ones you have written.

The example above would be used if you were expecting Company X stock to increase in price, but no higher than $52.00. In the event that Company X stock did move to exactly $52 by August 2020, you would be able to exercise the contracts you bought for a profit. The contracts you had written would expire worthless as the strike price would be equal to the price of the underlying stock, meaning you would also have profited from writing them.

In the event that Company X stock went higher than $52 you would make more profits on the contracts you had bought, but this would be offset by the losses you would incur on the contracts you had sold. Should the price of Company X stock fall, then you would lose the money you had invested in buying contracts, but this would at least be offset by the money you received for writing contracts.

The above example is known as a bull call spread. There are also different types of vertical spreads, as explained below.

Types of Vertical Spreads and Their Uses

Vertical spreads can be either bull vertical spreads or bear vertical spreads; you would use bull verticals when you were expecting the underlying security to increase in price and bear verticals when you were expecting the underlying security to fall in price. There are two further types of each based on whether you are using calls options or puts, for a total of four main types.

A bull call spread, as per the example above, involves buying calls that are usually in the money or at the money and offsetting some of the cost of taking that position by selling calls that are out of the money. A bull put spread involves selling puts that are in the money or at the money and reducing the exposure of taking this position, and the margin required, by buying puts that are out of the money.

A bear call spread involves buying out of the money calls to help reduce the exposure and margin from writing in the money or at the money calls. A bear put involves selling out of the money puts to offset some of the cost from buying in the money or at the money puts.

Difference between scaling horizontally and vertically for databases [closed]

Want to improve this question? Update the question so it focuses on one problem only by editing this post.

Closed last month .

I have come across many NoSQL databases and SQL databases. There are varying parameters to measure the strength and weaknesses of these databases and scalability is one of them. What is the difference between horizontally and vertically scaling these databases?

10 Answers 10

Horizontal scaling means that you scale by adding more machines into your pool of resources whereas Vertical scaling means that you scale by adding more power (CPU, RAM) to an existing machine.

An easy way to remember this is to think of a machine on a server rack, we add more machines across the horizontal direction and add more resources to a machine in the vertical direction.

In a database world horizontal-scaling is often based on the partitioning of the data i.e. each node contains only part of the data, in vertical-scaling the data resides on a single node and scaling is done through multi-core i.e. spreading the load between the CPU and RAM resources of that machine.

With horizontal-scaling it is often easier to scale dynamically by adding more machines into the existing pool – Vertical-scaling is often limited to the capacity of a single machine, scaling beyond that capacity often involves downtime and comes with an upper limit.

Good examples of horizontal scaling are Cassandra, MongoDB, Google Cloud Spanner .. and a good example of vertical scaling is MySQL – Amazon RDS (The cloud version of MySQL). It provides an easy way to scale vertically by switching from small to bigger machines. This process often involves downtime.

In-Memory Data Grids such as GigaSpaces XAP, Coherence etc.. are often optimized for both horizontal and vertical scaling simply because they’re not bound to disk. Horizontal-scaling through partitioning and vertical-scaling through multi-core support.

Scaling horizontally ===> Thousands of minions will do the work together for you.

Scaling vertically ===> One big hulk will do all the work for you.

Let’s start with the need for scaling that is increasing resources so that your system can now handle more requests than it earlier could.

When you realise your system is getting slow and is unable to handle the current number of requests, you need to scale the system.

This provides you with two options. Either you increase the resources in the server which you are using currently, i.e, increase the amount of RAM, CPU, GPU and other resources. This is known as vertical scaling.

Vertical scaling is typically costly. It does not make the system fault tolerant, i.e if you are scaling application running with single server, if that server goes down, your system will go down. Also the amount of threads remains the same in vertical scaling. Vertical scaling may require your system to go down for a moment when process takes place. Increasing resources on a server requires a restart and put your system down.

Another solution to this problem is increasing the amount of servers present in the system. This solution is highly used in the tech industry. This will eventually decrease the request per second rate in each server. If you need to scale the system, just add another server, and you are done. You would not be required to restart the system. Number of threads in each system decreases leading to high throughput. To segregate the requests, equally to each of the application server, you need to add load balancer which would act as reverse proxy to the web servers. This whole system can be called as a single cluster. Your system may contain a large number of requests which would require more amount of clusters like this.

Hope you get the whole concept of introducing scaling to the system.

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