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Understanding Call Spread Options

Options Trading


Call spreads options are simply a type of options strategy used to speculate on stock prices. This particular strategy is easy to understand, and it involves simultaneously buying and selling call options, at different strike prices, with the same expiration date. This allows traders to benefit from both short-term profits while also protecting their downside.


Traders usually use this strategy when they are attempting to forecast a stock's limited movement within a specific range. They will purchase the call option in their bullish outlook and then sell the call option at a higher price, which sets the maximum return potential on their position. Simultaneously they will sell the call option at a lower price in order to set the maximum loss potential on their position. Buying the two call options offers limited risk, but also reduced rewards.


A call spread options strategy can also be used when traders forecast a bearish outlook on a stock and have a pessimistic view of that stock's outlook. The long call option will create exposure to the gains in the stock price should the stock rise, and the short call option will set the maximum loss potential.


The call spread options strategy does have a risk-reward ratio, depending on where the stock prices settles at expiration. If the stock price settles at the higher strike price, then the trader will realize the entire difference between the two strike prices. If the stock price settles at the lower strike price, then the trader will realize a partial gain. If the stock price moves outside of the range of the two strike prices, then the trader will realize a maximum loss.


For example, if a trader sets up a spread that is long a call option at $50 per share and short a call option at $55 per share, then their risk-reward ratio is: 5:2 (five shares of stock risk per two shares of spread potential gain).


Ultimately, call spread options are considered lower risk options strategies, but they often require the trader to make careful assumptions about the direction the stock price will take. As with any options trading strategy, it is important for traders to have a clear understanding of the stock, the underlying concepts involved in options trading, and the strategies available to them.



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