Options Strategy VI ( Horizontal spreads )

We have already discussed what is a vertical spread. lets now discuss another options strategy

ie Horizontal Spreads..

In this strategy the strike price of the options remains the same whereas their expiry period differs.

As we already know options premium depends on time left for expiration of the option. ALL options have time value associated with them. As time passes by the premium of the options loses value. Also the closer you are to the expiration date the faster the value drops.

This spread takes advantage of this premium decay :) ( you can make money using options by using any situation ;) )


Let us take another example here :-0

Let's say we are now in the middle of July. We decide to perform a Horizontal Spread on a stock. For a particular strike price, let's say the August option has a premium of Rs4, and the September option has a premium of Rs4.50.

Now to make a horizontal spread , Sell the nearer option (in this case August), and buy the further option (in this case September). So you earn Rs 4.00 from the sale and spend Rs 4.50 on the purchase, netting you a Rs 0.50 cost. So your initial investment is Rs 0.50

Let's us assume august has come now and we are in the middle of august. The August option is fast approaching its expiration date, and the premium has dropped drastically, say down to Rs1.50. However, the September option still has another month's room, and the premium is still holding steady at Rs3.00.

At this point, we would close the spread position. We buy back the August option for Rs1.50, and sell the September option for Rs3.00. That gives us a profit of Rs1.50. When we deduct our initial cost of Rs0.50, we are left with a profit of Rs1.00.


That is basically how a Horizontal Spread works. The same technique can be used for Puts as well. Now Keep in mind that the price of stock has not moved at all and it remained the same.

To test this out take a stock whose price has remained the same( has not moved much) within the last two months and try paper trading on that stock and check it out. Poeple have been asking me to give some live examples. if i get time i will come out with some live examples too :)

Njoy reading.. more to come stay tuned ...