Rolling Into Spreads: Extend Profit Potential with Lower Risk

I had been a professional trader for nearly 15 years before I fell into trading options seriously. After a decade and half of a constant, high-stakes grind, I sold my stake in a successful trading firm and decided to take a year off from trading to recharge.

It was during that year that I became close friends with a neighbor of mine. He was a market maker at the Chicago Board Options Exchange (CBOE). He gave me a behind the scenes look at his operations — along with his trading statements — and I was blown away.

Despite all of my experience, I realized then there was a whole world of trading I hadn’t tapped into — options trading. I spent months managing his book for free, and after I got my sea legs, I decided to set out on my journey to become a market maker myself.

What drew me to options — and what keeps me coming back even after all these years — is their incredible versatility. Unlike stocks, options allow you to express a range of opinions about a stock’s future. Will it rise? Fall? Stay flat? With options, you can craft strategies to profit no matter the scenario.

This flexibility is why I now consider options the ultimate trading vehicle. They offer the perfect balance of leverage and risk management, which makes them the perfect instrument for traders to use their experience and creativity to find setups with truly explosive potential.

Options Provide Flexibility

With options, we’re not limited to simply buying or selling shares at the current stock price. Options traders have the ability to express their opinions on a specific company, fund, or commodity in a variety of ways. Not only can we choose directionality with calls and puts, but we can also choose what price levels we want to target…

If we think Apple Inc. (AAPL) is going to $250, we can buy the $250 out-of-the-money calls instead of buying the at-the-money $225 calls, getting our portfolio leveraged exposure to the rise in share price — usually at a fraction of the cost.

The downside, of course, is that there’s no guarantee Apple will go up, let alone approach that $250 mark before our options expire. If an option expires out of the money (OTM), its value drops to zero and we lose our initial investment. That might sound scary, but it’s also one of the reasons options are such a powerful tool when used strategically.

Unlike buying the stock outright, where a drop in price could wipe out a significant portion of your portfolio, with options your maximum loss is capped at the initial premium you paid. This built-in risk limitation is a safety net available to traders that far too many overlook.

Even better, options offer flexibility that allows us to adapt our trades to changing market conditions.

If we’re holding that $250 call and Apple starts moving in the right direction, but stalls around $240, we’re not stuck watching our trade decay into a loss… Instead, we can take action and transform that single call into a vertical spread by selling a higher strike call, say at $260. Doing this brings in premium that reduces our initial cost, lowers our breakeven point, and keeps the trade alive with a more defined risk and reward.

Let’s break that down a little…

What Is a Vertical Spread?

Simply put, vertical spreads are positions that require us to buy and sell options of the same type and expiration date at different strike prices. When we say “vertical,” we’re referring to the position of the strike prices – essentially, one position offsets the other, which defines whether it’s a credit or debit spread.

Here’s a simple rule of thumb… Bullish vertical spreads increase in value when the underlying asset rises. Conversely, bearish vertical spreads profit from a decline in price.

Going a little deeper, a bullish vertical spread would require us to buy a bullish call spread and a bullish put spread. We simply buy the option with the lower strike price and sell the option with the higher strike price. 

A bearish vertical spread requires us to use bearish call spreads or bearish put spreads. We then sell the option with the lower strike price and buy the option with the higher strike price.

In both scenarios, we need to understand the role of debits and credits.

Debit, Credit, and Implied Volatility in Vertical Spreads

A credit is simplymoney received in an account. A credit transaction is one in which the net sale proceeds are larger than the net buy proceeds (cost), thereby bringing money into the account.  

On the other side, a debit is an expense, or money paid out from an account. A debit transaction is one in which the net cost is greater than the net sale proceeds.

If we think about the examples above, the bullish call spread actually produces a net debit while the bullish put spread results in a net credit at the outset. 

When we talk about debits and credits, we’re specifically paying attention to how volatility affects the overall trajectory of our trades. In this sense, we must always be aware of how Implied Volatility (IV) affects our overall thesis. This is a measurement of how much the price of an option’s underlying stock is expected to fluctuate over the life of the options contract (non-directional).  

Now that we have some terms in mind for understanding how vertical spreads work, let’s take a high-level look at the different types of vertical spreads…

The Types of Vertical Spreads

1. Long Call Spread (Bull Call Spread): This is a bullish, defined-risk strategy where we trade a long and short call on the same underlying asset within the same expiration date at different strikes. The short call strike is higher than the long call strike. This places a ceiling on our profit potential in the long call while covering the overall risk and cost of the position.
    
   You’ll capture a maximum profit if the market price is at or above the short call strike price at expiry. Your maximum loss would occur if the underlying price is at or below the long call strike price.
    
2. Short Call Spread (Bear Call Spread): This vertical spread is a bearish, defined-risk strategy where we trade a short and long call at different strikes using the same expiration. Both strikes are out of the money (OTM), with the short strike being closer to the stock price.
    
   If the position expires worthless and OTM at expiration, your maximum profit potential is the credit received upfront, which is capped at the net premium you collected. Your maximum loss would be the value equal to or above the long call’s strike price. Losses are essentially limited to the difference between the call strikes, minus the net premium collected upfront.
    
3. Long Put Spread (Bear Put Spread): This is a bearish, defined-risk strategy made up of a short and long put at different strikes using the same expiry. The strike price of the long put is higher than the short put. The value of a long put vertical spread increases when there’s a drop in the price of the underlying asset.
    
   You’d capture the maximum profit potential if the market price at expiration is at or below the short put’s strike price. You’d capture your largest possible loss if it’s equal to or above the long put’s strike price.
    
4. Short Put Spread (Bull Put Spread): This is a bullish, defined-risk strategy where we trade a long and short put at different strikes using the same expiry. The strike price of the short put is higher than the long put. This means the value of a short put vertical spread will decrease when there’s a rise in the price of the underlying asset.
    
   You’d capture the highest possible profit if the market price at expiration is at or above the short put’s strike price. You’d take the biggest possible loss if it’s equal to or below the long put’s strike price.

The Power of Rolling Into Spreads  

With vertical spreads, we have the power to target our upside and downside exposure without risking all of the capital we’ve put up on a single trade.

Many of our positions make use of these kinds of spreads in particular not only because they limit our risk… They also provide us different options for trade management based on whatever the markets throw at us. That’s what’s truly powerful about these trades – they allow us to stay nimble and adapt to wherever our chosen stock is heading.

• Define Your Maximum Investment and Risk: Vertical spreads allow us to define and manage the maximum we can possibly lose on any position.

Let’s say you’re holding a call option on Apple, and the stock has risen significantly. Instead of simply selling, consider rolling into a vertical spread by selling another call at a higher strike price. Here’s why this is powerful:

• How It’s Done: When AAPL rises, you can sell a higher-strike call option against your existing position. This locks in part of your gains and reduces the position’s risk, while still keeping some upside potential.
• Why It Works: A spread gives you extended exposure to AAPL’s potential rise but with less capital at risk. It’s a favorite approach for traders who want to stay in the game without putting all their chips on the line.

Pro Tip: Use spreads to set guardrails on your trades. They’re especially useful in volatile markets, where you want some protection in case of a sudden reversal.

Now you have an overview of how vertical spreads work and an understanding of precisely why they’re so powerful. But before we wrap up, I’d like to show you one last example… I think it drives home exactly why vertical spreads are key to our overall strategy.

Recently, a member of our Discord asked about a vertical spread trade they placed on a battery maker. They were curious if their approach could lock in profits while effectively managing risk.

In this video, I break down the mechanics of vertical spreads and highlight why this strategy is such a powerful tool for options traders and why being part of a collaborative trading community can help make all the difference.

Thanks for reading,

Jonathan Rose