17.13 Basic spreads

By combining options and/or stock into spreads, the investor can add even more flexibility to his or her investment planning. Most complex option spreads have as their foundation one of two basic spreads. They both involve buying one option and writing another. Options spreads are divided into three different classifications, which include the horizontal spread, the vertical spread, and the diagonal spread. The options are classified according to strike price and expiration dates.

Horizontal spreads are also known as calendar or time spreads. These types of spreads consist of options with the same underlying security and strike prices. The options in this class have different expiration dates, though.

Vertical spreads are also called money spreads. These spreads contain options with the same underlying security and expiration month. However, the options have different strike prices.

Diagonal spreads consist of a sort of combination of the vertical and horizontal spread classification. The options in this class have the same underlying security, but have different strike prices and different expiration dates. They are called diagonal spreads because they are a combination of vertical and horizontal spreads. Within these three spreads classifications, spreads are also classified by what they are designed to do.

There are call and put spreads, bull and bear spreads, credit and debit spreads, ratio spreads and back spreads, and spread combinations.