Vertical spread
Also written Bull call spread · Bear put spread · Bull put spread · Bear call spread · Price spread
Two options of the same type and the same expiry but different strikes, one bought and one sold — a limited-profit, limited-loss position that trades away part of the upside to cut the cost or cap the risk.
In plain language
A spread combines options on the same underlying and of the same type — calls with calls, puts with puts. A vertical spread is the version where the two legs share an expiry date and differ only in strike. (A horizontal spread differs only in expiry; a diagonal differs in both.)
The logic is always the same trade. A naked long option is expensive; a naked short option has a tail that never ends. Add the opposite leg at a different strike and you fix whichever of those you cannot live with — at the price of fixing the other end too.
Every vertical spread is limited profit and limited loss. There are four of them, and they divide on two questions: is the view bullish or bearish, and is the position built from calls or puts.
How it works
The four combinations, all on a spot of 17,500:
| Spread | Legs | Net | Max profit | Max loss | BEP |
|---|---|---|---|---|---|
| Bull call | Long 17,500 call @185, short 17,800 call @61 | Debit 124 | 176 | 124 | 17,624 |
| Bear call | Short 17,500 call @185, long 17,800 call @61 | Credit 124 | 124 | 176 | 17,624 |
| Bull put | Short 17,500 put @125, long 17,000 put @34 | Credit 91 | 91 | 409 | 17,409 |
| Bear put | Long 17,500 put @125, short 17,000 put @34 | Debit 91 | 409 | 91 | 17,409 |
Read the table in pairs. The bull call and the bear call are the same two contracts with the signs flipped, so their break-even is identical and their maximum profit and loss simply exchange places. The same is true of the two put spreads. A single break-even serves a spread and its mirror, exactly as it does for a single option.
Two rules cover the arithmetic:
- Debit spread (you pay to open): break-even = lower strike + net premium paid. Maximum profit = strike difference − net premium.
- Credit spread (you receive to open): break-even = higher strike − net premium received. Maximum profit = the net premium.
The workbook adds the practical caution on strike choice: pushing the short call further out to capture more upside raises the cost only marginally, because the further strikes fetch less and less premium.
The formula
Net premium = Premium paid − Premium received
Bull call spread (debit, calls)
BEP = Lower strike + Net premium paid
Max profit = (Higher strike − Lower strike) − Net premium paid
Max loss = Net premium paid
Bull put spread (credit, puts)
BEP = Higher strike − Net premium received
Max profit = Net premium received
Max loss = (Higher strike − Lower strike) − Net premium received
A worked example
A trader is bullish on the index at 17,500 but does not expect it above 17,800. He builds a bull call spread with a contract size of 50.
Buy 17,500 call @ Rs 185 → outflow 185 × 50 = Rs 9,250
Sell 17,800 call @ Rs 61 → inflow 61 × 50 = Rs 3,050
Net debit = Rs 6,200 (124 points)
| Index at expiry | Long call | Short call | Net |
|---|---|---|---|
| 17,500 | −185 | +61 | −124 |
| 17,600 | −85 | +61 | −24 |
| 17,624 | −61 | +61 | 0 |
| 17,700 | +15 | +61 | +76 |
| 17,800 | +115 | +61 | +176 |
| 18,000 | +315 | −139 | +176 |
In rupees on one lot: maximum profit Rs 8,800, maximum loss Rs 6,200, break-even at 17,624.
What the short leg actually bought him. The naked 17,500 call alone would have cost Rs 9,250 and broken even at 17,685. Selling the 17,800 call cut the outlay by Rs 3,050 — a third — and pulled the break-even 61 points nearer, down to 17,624.
What it cost: at 18,000 the naked call earns Rs 315 a unit, Rs 15,750 a lot, while the spread is stuck at Rs 8,800. The trader gave away Rs 6,950 on that outcome to save Rs 3,050 up front and to get paid 61 points sooner.
That is the trade in one sentence: a spread is cheaper, breaks even earlier, and is capped. It is the right structure when the view has a target, and the wrong one when it does not.
Why NISM asks about it
Chapter 17.2 (Use of Options for Trading and Hedging) sets out spreads as vertical, horizontal and diagonal, then works all four vertical variants with the exact premiums used above. The Chapter 17 sample questions include the classic identification: buying a lower-strike call and selling a higher-strike call on the same underlying and expiry is a bullish spread. Expect that, plus a max-profit or break-even computation.
Common exam traps
- Vertical means same expiry, different strikes. Horizontal (calendar) means same strike, different expiries; diagonal means both differ. The workbook notes you cannot even draw a payoff chart for the latter two, since the legs expire on different days.
- Use the net premium in the break-even, never one leg's premium. This is the single commonest arithmetic slip in the chapter.
- A bullish view can be expressed with calls or with puts. Bull call is a debit; bull put is a credit. "Puts means bearish" is wrong.
- A spread and its mirror share a break-even. Only the sign of the profit flips.
- Max loss on a credit spread is not the premium received — it is the strike difference minus that premium, and it is the larger number.
- Both legs must be opened together. The workbook warns that any delay between legs erodes or destroys the intended economics.
Where this is taught
- Series VIII · Chapter 5: Strategies using Equity Futures and Equity Optionsintroduced here
- Series V-D · Chapter 17: Strategies using Equity Futures and Equity Optionsintroduced here
- Series XVI · Chapter 5: Uses of Commodity Derivativesintroduced here
- Series IV · Chapter 5: Strategies using Interest Rate Derivativesintroduced here
- Series I · Chapter 5: Strategies using Exchange Traded Currency Derivativesintroduced here
- Series V-D · Chapter 22: Strategies using Interest Rate Derivatives
Related terms
- Break-even pointThe level of the underlying at which a position makes neither profit nor loss — for a bought call, strike plus premium; for a bought put, strike minus premium.
- Butterfly spreadA four-legged position — one option bought at a low strike, two sold at a middle strike and one bought at a high strike, all of the same expiry — that caps the unlimited loss of a short straddle.
- Call optionA contract giving its buyer the right, but never the obligation, to buy the underlying at a fixed strike price — so the loss is capped at the premium and the gain is not.
- Long straddleBuying a call and a put at the same strike and the same expiry — a bet that the underlying moves a long way in either direction, with two break-even points and a maximum loss equal to both premiums.
- Covered callHolding the underlying in the cash market and writing a call against it — a way of earning premium income from a holding, at the cost of capping the gain above the strike.
- Option premiumThe price an option buyer pays the seller for the right the contract carries — non-refundable, and made up of intrinsic value plus time value.
- Put optionA contract giving its buyer the right, but never the obligation, to sell the underlying at a fixed strike price — insurance against a fall, bought for a premium.
- Horizontal spreadTwo options of the same type and the same strike but different expiries — a position whose entire value is the difference between the two legs' time values, not a view on direction.
- Diagonal spreadTwo options of the same type on the same underlying with both a different strike and a different expiry — the most complicated of the three spread families, and the only one that varies on both axes.