SPREADS A spread trading strategy involves taking a position in two or more options of the same type (i.e., two or more calls or two or more puts).
Bull Spreads can be created by buying a European call option on a stock with a certain strike price and selling a European call option on the same stock with a higher strike price. Both options have the same expiration date.
Bull spreads can also be created by buying a European put with a low strike price and selling a European put with a high strike price, as illustrated in Figure 11.3. Unlike bull spreads created from calls, those created from puts involve a positive up-front cash ﬂow to the investor (ignoring margin requirements) and a payoﬀ that is either negative or zero.
Bear Spreads An investor who enters into a bull spread is hoping that the stock price will increase. By contrast, an investor who enters into a bear spread is hoping that the stock price will decline. Bear spreads can be created by buying a European put with one strike price and selling a European put with another strike price. The strike price of the option purchased is greater than the strike price of the option sold.
A butterﬂy spread involves positions in options with three diﬀerent strike prices. It can be created by buying a European call option with a relatively low strike price K1, buying a European call option with a relatively high strike price K3, and selling two European call options with a strike price K2 that is halfway between K1 and K3. Generally, K2 is close to the current stock price.