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When to Trade Vertical Spreads

by Yash Ranjan
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The post-crisis period has produced a large number of very confident traders. The stock market is once again recording all-time highs almost weekly. Many are turning to trade vertical spreads to speculate on the market’s direction without the need for deep pockets or high-risk tolerance.

What Are Vertical Spreads?

Vertical spreads are options positions that consist of both a long and short spot on the similar underlying stock. The investor is betting that the volatility will be low, which means they are similarly betting that the spot value of the underlying asset will not move much. Therefore, the investor is trying to make money when the underlying stock price stays within certain ranges without experiencing too high volatility. Vertical spreads can offer some benefit to investors, but they also come with two big issues.

Why Trade Vertical Spreads

Some of the benefits of vertical trading spreads are that investors can make money if their prediction is correct and limit their losses if they are incorrect. There are two major issues with this type of trade. The first issue is that it may be difficult for traders to determine whether or not a volatile situation will happen. The second issue with this type of trade is that an investment in long/short options has expiration dates, which means investors could lose money before the expiration date arrives if their prediction isn’t accurate.

When to Trade Vertical Spreads

This type of trade is wise when the investor wants to speculate on a stock that might become volatile in a short amount of time. Here is when to trade vertical spreads.

When A Company Is About to Release an Earnings Report

It will usually cause the stock to move up or down, depending on how investors feel about the report. An investor can purchase a vertical spread by timing it correctly, and they may be able to make money if they are correct in their prediction.

When the Stock Is Experiencing High Volatility

This means that the investor can make money if they are correct in their prediction. If they are wrong, they will experience short-term losses before the expiration of the options.

When There Is a Huge Drop in The Stock Price

This is the best time to trade vertical spreads because they are most likely to profit when a major drop in the stock price has been. If their prediction is correct, they will profit quickly.

When There Are Significant News Releases About the Stock

The release of a bad earnings report could cause the stock price to drop. The investor may want to sell their vertical spreads when this event occurs.

When There Is a Bubble and Stocks Are Becoming Too Expensive

This will cause the stock to rise, and the investor will make money if they are correct in their prediction. There might not be sufficient time to sell their vertical spread before it expires if they are wrong.

Anytime A Company Is Going Private

The investor may be able to buy vertical spreads when a company is about to go private. If they are correct, they may profit from the trade.

When the Investor Has an Opinion of What Will Happen with A Particular Stock Price

According to tastytrade, “They can purchase a vertical spread if they think that the stock will rise or fall in a certain amount of time.” This type of trade can be beneficial if the price is correct before expiration. 

When There Is Fear of Bad News

A pessimistic investor may be able to make money by purchasing vertical spreads when there is fear about bad news. It would usually occur when there has been a large drop in the stock price or when the company gives off poor earnings reports that cause investors to panic and demand that the company goes private.

Vertical spreads are an options strategy meant to make money in low volatility periods. Due to their high risk, investors should only trade these options when it is probable that they will be profitable in the long term. After all, in most cases, they are not even covered by the financial institution that the investor is using.

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