Vertical Spread

An option has three basic components. It has an underlying security, a strike price, and an expiration. Options for different underlying assets (a stock, a commodity, a currency, etc.) just mean different bets on different things. They can be packaged together in a cohesive strategy, but we’re not really interested in those here.

For defining a vertical spread, we're interested in the other two aspects: strike price and expiration.

Imagine these components charted on a graph. Expiration appears on the X-axis, different time periods spreading out in front of you like a timeline. These are arranged horizontally. Now picture the Y-axis, showing different strike prices. These points appear vertically, suggesting higher and lower prices. A vertical spread involves an options strategy that consists of multiple strike prices. It takes advantage of differences along that Y-axis.

Each option has the same underlying asset and the same expiration, but they have different strike prices. The options involved can either be puts or calls. The strategy allows you to prepare for different levels of price movement from the underlying asset. You can take a bet on a big move, taking an option with a strike price well out of the money. Meanwhile, you can hedge that with a less aggressive option with a strike price closer to the current trading price of the asset.

You buy a call option for 100 shares of WMT, with a strike price of $115 and an expiration in October. You also buy another call option for 100 shares of WMT, with a strike price of $120 and an expiration in October. That situation represents a vertical spread. You have options for strike prices of $115 and $120, both with WMT shares as the underlying asset and an expiration in October.