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What Is Spread Option Trading? Get the Details

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Written by Timothy Sykes
Updated 4/21/2023 7 min read

Spread option trading is an options trading strategy that involves spread options. Spread options shouldn’t be confused with options spreads. They’re two different things.

So, what is spread option trading, and how does it differ from options spreads? Let’s dive in!

What Is a Spread Option?

A spread option is an options contract that gets value from the spread between asset prices.

Most spreads are based on price differences between two or more assets. But spreads can also be based on interest rates, the production process, and currency differences. This means spread options aren’t just for stocks — you can also find commodity spread options.

An example of spread options using the production process is when you buy oil options. The value difference between crude oil and gasoline is called the ‘crack spread.’ It’s a more technical alternative to trading these commodities. If a trader thinks that refined products will grow in value compared to crude oil, they believe the crack spread will get stronger.

Spread options are unique because they draw value from multiple underlying assets. But aside from that, they act just like regular options contracts. That means you can implement spread options in your option spread strategies.

I know that sounds confusing, but bear with me…

Do you get taxed on options trading gains? Check out my post about taxes on options trading.

Example of a Spread Option

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Spread options get their value from the price difference between two or more assets. These assets are usually different. For instance, you can buy an option for the stock price spread between Stock A and Stock B.

Sometimes spread options represent the same commodity or asset. They usually derive value from the price difference between a product’s input and output.

A good example of a spread option taking value from the spread between input and output is a ‘crush option.’ A crush option takes value from the price spread between raw soybeans and soybean oil. There are also ‘spark options’ between the price of electricity and its production cost.

Spread Option Strategies

Spread options behave similarly to regular options. That means you can use any option strategy with spread options.

That includes:

  • Covered calls
  • Covered puts
  • Long calls
  • Long puts
  • Short puts
  • Married puts
  • Straddles
  • Butterfly spreads
  • Iron condors

You can also use options spreads with spread options.

What Is a Spread Transaction?

A spread transaction involves the simultaneous purchase and sale of options contracts. The combination of contracts must have related underlying stocks to be a spread transaction.

Traders make spread trades to produce a spread. Spreads represent the gap between the prices of these two options contracts.

Spreads usually have positive values. These spreads can be used to minimize your maximum risk. They can also improve your maximum profit potential.

Anything you can do to minimize your risk is important. Read my article on why options trading is risky.

How Do Options Spreads Work?

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Options spreads work when you trade multiple options with the same underlying asset. Options spreads are typically used to minimize risk. They can also increase your probability of success.

There are two main types of spreads:

  • Horizontal Spread (aka Calendar Spread): In a horizontal spread strategy, you buy options with the same strike price but different expiration dates. Horizontal spreads let you profit from the options contracts’ time decay.
  • Vertical Spread (aka Money Spread): In a vertical spread, you buy options with the same expiration dates but different strike prices. Vertical spreads limit your downside risk, but they also cap your potential profits.

There’s also a combination called a diagonal spread. In a diagonal spread, you buy options on the same asset with different expiry dates and strike prices.

Options spreads often use regular options contracts. But you can use spread options in your option spread strategies as long as the underlying asset is the same.

Options spreads are usually available for more advanced traders. Check out my guide to levels of option trading.

What Is the Best Options Spread Strategy?

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There’s no one “best options spread strategy” for everyone. Each options spread strategy has different uses and fits different needs.

The best way to figure out what works for you is to try out every strategy you’re interested in. Keep a thorough trading journal, so you can see the strategies that actually work best for you!

Don’t try out “every” options strategy — at least not unprepared. Check out my guide to the best binary options trading platforms.

How to Close Your Spreads

Closing your spread means exiting the trade to avoid losses or to lock profits in. You can close spread positions at any time before your options expire.

How do you close the spread? You can close the spread by selling the options before they expire. You might not get maximum potential gains, but you’ll minimize your losses.

Stop-losses are a way to minimize risk when trading options. Read more about stop-losses in options trading.

Key Takeaways

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Spread options and options spreads might sound similar, but they’re two different concepts.

Spread options derive value from the price differences between two assets. Meanwhile, options spreads are a popular strategy for hedging. Options spreads involve trading options at different strike prices or expiration dates.

Spread options act like regular options, and you can trade them with most options strategies. Meanwhile, options spreads use more advanced options strategies.

Experience and trading mentality are among the most important things when trading options. There’s no better way to improve them than to make trades, but you can’t go about it blindly.

I recommend getting some expert guidance. In the options world, I think there’s no better mentor than my former student Mark Croock.

Mark has racked up $4 million in career earnings, mostly from trading options. He’s done this by adapting my penny stock trading strategies to options. Before he was a teacher, he was one of my best students — watching every single webinar in the Trading Challenge 2 or 3 times!

Now he’s got his own mentorship program, called the Evolved Trader. Check it out for strategy sessions, trade alerts, a great chat room, and more!

Have you traded spread options? Let me know in the comments!

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Author card Timothy Sykes picture

Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”