Vertical spread
A vertical spread is an strategy that combines buying and selling two of the same type, both calls or both puts, on the same underlying with the same but different . The two strikes create a defined range of potential profit and loss, which is the main appeal of the strategy compared to buying or selling a single option outright.
A bull call spread is built by buying a call at a lower and selling a call at a higher . It is used when an investor expects the to rise, and it reduces the upfront cost compared to buying the call alone, since the premium received from selling the higher strike call offsets part of what was paid for the lower strike call. The tradeoff is that potential profit is capped, once the rises above the higher strike, further gains are given up because the short call caps the payoff.
A bear put spread works the same way in the opposite direction, buying a put at a higher and selling a put at a lower , used when an investor expects the to fall. It reduces the cost of the bearish bet compared to buying the put alone, while capping the maximum profit once the falls below the lower strike. In both versions, the maximum loss is limited to the net premium paid for the spread, which makes vertical spreads a way to take a directional view with defined, known risk and a lower cost than an outright option position, at the expense of giving up unlimited upside or downside potential.