Horizontal Spreads

How Do Horizontal Spreads Work in Options Trading?

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Horizontal Spreads - Introduction

Almost all options strategies are made up of what are known as spreads. Options Spreads are simply simultaneously buying and shorting different options of the same type on the same underlying stock. For example, Buying a $30 strike Call Option and simultaneously shorting its $33 strike call option is a spread. Spreads are extremely important in options trading because spreads enable different risk/reward profiles to be created, giving options trading its legendary versatility. There are many types of spreads namely; Horizontal Spreads, Diagonal Spreads, Ratio Spreads and Horizontal Spreads. This tutorial shall explain what Horizontal Spreads are and explore the different types of Horizontal Spreads.

Horizontal Spreads - Content

What are Horizontal Spreads | Types of Horizontal Spreads | Purpose of Horizontal Spreads | Advantages and Disadvantages

What are Horizontal Spreads?

Horizontal Spreads, also known as Time Spreads or Calendar Spreads, are options spreads made up of options of the same underlying, same type, same strike price but different expiration months. Horizontal Spreads are named Horizontal Spreads because the options that are involved in a Horizontal spread are lined up horizontally on an options chain.

The example in the picture above is a Calendar Call Spread on the QQQQ buying its December $30 strike call options and shorting its April $30 call options. Yes, Calendar Call Spreads are Horizontal Spreads as well.

Horizontal spread is simply a way of classifying options strategies using options of the same type and strike but different months. Knowing or not knowing such classification does not actually affect your options trading in anyway.

Types of Horizontal Spreads

Horizontal Spreads profit primarily from difference in time decay between the longer term options and the shorter term options, that is why horizontal spreads are also known as Time Spreads or Calendar Spreads. There are 2 main types of Horizontal Spreads; Call Spreads and Put Spreads.

Call Horizontal Spreads are Horizontal Spreads utilizing call options. These are also more popularly known as Calendar Call Spreads.

Put Horizontal Spreads are Horizontal spreads utilizing put options. These are also more popularly known as Calendar Put Spreads.

The terms Time Spread and Calendar Spread refers to Diagonal Spreads as well.

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Purpose of Horizontal Spreads

The primary purpose for Horizontal Spreads is to profit from a neutral outlook through the difference in time decay between the longer term options and the shorter term options. Short term options have a higher theta value and hence a higher rate of time decay than longer term options. By making more in time decay from the short term options than what is lost in the long term options, a positive return results. In this case, the longer term options serve to eliminate the margin requirement of shorting the short term options. If margin is not an issue, one could simply short the near term options and take advantage of the full time decay without offsetting by the long term options.

The longer term options also serve to offset losses if the underlying stock should breakout strongly. For example, if the underlying stock surges suddenly in a call horizontal spread, losses from the short term options will be partially offset by the gain in the longer term option. However, this property works the other way as well. If the underlying stock should breakout strongly the other way, the gains in the short term options might not cover the loss in the longer term options, producing a net loss.

Horizontal spreads are also capable of profiting from increases in implied volatility as the vega value of longer term options is higher than the vega value of nearer term options. However, this is not the primary purpose of putting on a horizontal spread because a better way to take advantage of volatility is through the use of volatile options strategies or simply by buying the long term options without offsetting by the nearer term options.

Horizontal Spreads can also be quickly skewed into a Diagonal Spread or Ratio Spread in order to introduce directional bias into the position if the underlying stock should stage a breakout.

Advantages of Horizontal Spreads

Elimination or lowering of margin requirement when shorting near term options.

Capable of profiting from volatility as well as time decay.

Disadvantages of Horizontal Spreads

Higher commissions due to additional trades.

Lower maximum profit when putting on credit options trading positions.

Changes maximum profit potential of call or put spreads from unlimited to limited.

Closer losing point than Diagonal Ratio Spreads or Vertical Ratio Spreads.

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