What is a spread trade?

 

Video Transcription

Hello, again, Casey Jensen here at Options Animal. Now, we're discussing what a spread is. Let me put it this way. Take a look at this options chain. First, you need to look at the strike price so if you're buying a call option ... Let's say you buy strike price 40 here. You buy this call option. It costs you $0.85. You're going to make money as the stock goes up, and you can make a lot of money that way. You can go out and, compare it to baseball, you can hit a few home runs. The problem with doing it this way is you're exposed to risk on the downside. If the stock drops, I mean you could lose that $0.85 quickly. How do you avoid that? You do a spread.

A spread is going to limit your risk. It'll limit your upside potential a little bit. Again, comparing it to baseball, now I might be trying to just bunt or hit a single. We're trying to get on base all the time and be consistent, and that's one of the ways we found helps us here at Options Animal. How does the spread work? How do you incorporate it? What you do is you buy that same call option. You still buy strike price 40, perhaps. You feel like the stocks headed up but rather than just being all in and having no risk management, now what you do is you sell strike price 45. Now, you have what's called a bull call spread. Now, the spread is simply just the difference here between 45 and 40. It's a $5 spread.

If the stock goes up, you're still going to make money. Not quite as much, but again we're trying to hit singles. We're trying to get on base, and that's what a spread will do. It limits your risk, and it still helps you to make a really good consistent profit.