Options Spreads: Conclusion
Published orginally at Investopedia.com
By John Summa, CTA, PhD, Founder of OptionsNerd.com
If you plan to use options spreads, you will discover that they have some major advantages over outrights. In fact, the full power of options as a trading vehicle doesn’t really become known until you develop a good understanding of the workings of spreads. Most importantly, the selling side of option spreads has the greatest potential because you can profit from both time value decay and leverage of holding a long option in, for example, a diagonal spread. Even if using debit spreads, however, there are excellent hidden advantages mostly overlooked by novice traders. Certain debit spreads, for instance, can give you the ability to profit from time value decay (on a short out of the money leg) and potentially gain on the long side (from an in-the-money leg).
The advantage with the in the money debit spread is that you can cover the short option with a long in-the-money option instead of holding the stock itself, which entails much greater risk. And reducing risk is really what spreads are all about.
Risk reduction that is greater than the reduction in potential reward, ideally, means that you develop a trading advantage. Spreads offer that possibility if done correctly. Overall, given the ideas presented here, you should be able to expand your available trading options, and provide yourself with further opportunities for a payoff in the long run.