Module 8 · Lesson 12 of 13 · Options · About 5 minutes
Vertical Spreads: Defined-Risk Payoffs With Two Strikes
On this page
Before you read: Option Payoff Diagrams: Long and Short Calls and Puts
What you will learn
- How a vertical spread combines two options of the same type and expiration at different strikes.
- How debit spreads and credit spreads differ.
- How maximum gain, maximum loss and break-even are calculated at expiration.
What is a vertical spread?
What happens when you buy one call and sell another at a higher strike?
A matched vertical has equal quantities of two options of the same type, underlying, expiry and contract deliverable, but different strikes. Declare which is long/short. The examples here use one contract per leg, unadjusted 100 shares per contract, American-style physically share-settled equity options, and fictional premiums in dollars/share.
The familiar debit or width-minus-credit limits describe the intact matched expiry payoff, with both legs valued consistently at the same underlying price. They are not a guarantee of maximum account-level loss through leg execution, early assignment, unequal exercise/expiry or resulting stock positions. Fees, slippage and financing are additional; adjusted deliverables or mismatched quantities/expiries need different arithmetic. See Option Payoff Diagrams: Long and Short Calls and Puts, Exercise, Assignment and Settlement: What Happens at Expiration and Index Options, ETF Options and Options on Futures Compared.
A fictional debit spread
If the 100 call costs $4 and the 105 call is sold for $1.50, what are the limits?
Buy one 100 call at $4/share; sell one 105 call at $1.50/share, same expiry/deliverable. Net debit 4−1.50=$2.50/share=$250 per pair. Width $5/share=$500 per pair. Intact terminal intrinsic value=max(S−100,0)−max(S−105,0); subtract 2.50 for gross P&L/share.
| Common expiry S | Intrinsic spread/share | Gross P&L/share | Gross P&L/pair | Net after fixed $4 pair costs |
|---|---|---|---|---|
| 100 | 0 | -2.5 | -250.0 | -254.0 |
| 102.5 | 2.5 | 0.0 | 0.0 | -4.0 |
| 103 | 3 | 0.5 | 50.0 | 46.0 |
| 105 | 5 | 2.5 | 250.0 | 246.0 |
| 110 | 5 | 2.5 | 250.0 | 246.0 |
Before costs, maximum loss $250, maximum gain (5−2.50)×100=$250; break-even S 102.50. If a fictional $4 fixed total cost covers the whole two-leg position lifecycle under the intact-payoff assumptions, net maximum gain $246/net maximum loss $254 and cost-adjusted break-even 102.54. That fee is NOT $4 per leg, per contract or per side; actual costs can differ.
Why the boundary matters: stipulate that the long 100 call is exercised but the short 105 call is NOT assigned and expires. Exercise buys 100 shares for $10,000; the short did not create a matching sale. If that now-unhedged stock is later sold at fictional 95, the receipts are $9,500. Whole sequence before costs=9,500−10,000−250=−$750, not the intact option diagram’s −$250 bound. This is a different resulting position/time interval, not a flaw in the simultaneous payoff equation or a forecast of assignment. Broker instructions, deadlines, liquidation and financing can change actual outcomes.
Vertical spread diagram
Read the diagram step by step
- One contract per leg, unadjusted 100 shares each; American-style physically share-settled equity options. Intact intrinsic comparison at the SAME S. Curves are GROSS, before costs.
- SEPARATE net-cost legend · NOT the curves
- Fixed $4 TOTAL whole-pair lifecycle cost, not per leg, contract or side. Call net extrema −$254 / +$246 per pair; BE S 102.54. Put −$384 / +$116 per pair; BE S 93.84. Break-evens are underlying $/share.
- Intact payoff is not an account guarantee not account-level limit after unequal exercise/assignment/resulting stock.
- Fictional intact matched expiry payoffs before costs; the separate declared cost overlay changes net bounds/break-evens. Assignment/unequal exercise can leave stock exposure outside this diagram’s scope.
Illustrative diagram constructed for teaching. Not real market data.
Fictional intact matched expiry payoffs before costs; the separate declared cost overlay changes net bounds/break-evens. Assignment/unequal exercise can leave stock exposure outside this diagram’s scope.
A fictional credit spread
What if the higher-premium option is the one sold?
Sell one 95 put for $2/share; buy one 90 put for $0.80/share, same expiry/deliverable. Credit $1.20/share=$120 per pair; gross intact expiry P&L/share=1.20−max(95−S,0)+max(90−S,0).
| Common expiry S | Intrinsic leg sum/share | Gross P&L/share | Gross P&L/pair | Net after fixed $4 pair costs |
|---|---|---|---|---|
| 85 | -5 | -3.8 | -380.0 | -384.0 |
| 90 | -5 | -3.8 | -380.0 | -384.0 |
| 93.8 | -1.2 | 0.0 | 0.0 | -4.0 |
| 94 | -1 | 0.2 | 20.0 | 16.0 |
| 95 | 0 | 1.2 | 120.0 | 116.0 |
| 100 | 0 | 1.2 | 120.0 | 116.0 |
Before costs, maximum gain $120; maximum loss (5−1.20)×100=$380; break-even 93.80. Under the same fictional fixed $4 whole-pair cost assumption, net maximum gain $116/net maximum loss $384 and cost-adjusted break-even 93.84. The cost moves the break-even upward for this positive-slope payoff.
American short puts can be assigned before expiry; the long put is not automatically exercised at the same time. Assignment on one 95 short put buys 100 shares for $9,500; the 90 put may still exist then, so do not falsely say early assignment alone necessarily destroys all protection. But if the 90 put instead expires unexercised while assigned stock remains, its later exposure is different. With a stipulated later sale of those 100 shares at 85 and no remaining option hedge, the full sequence=8,500−9,500+120=−$880 before costs, outside the intact −$380 expiry bound. This is a chosen asymmetric exercise/expiry scenario, not the price path used in the payoff table.
Near a strike, exercise/assignment is not certain just because of the closing print; postmarket moves and holder instructions can matter. Broker cutoffs, stock/cash needs, dividends, borrowing/financing and unequal leg actions require product-specific handling. Do not guess a firm’s policy from a payoff diagram.
What this does not tell you about vertical spreads
- Values before expiration, which depend on time and volatility.
- Whether any spread suits anyone.
- Real premiums or commissions.
- Nothing here recommends any option trade.
Method in Practice: a defined-risk spread
Fictional example. John, Harbor Index futures, the prices, times, costs and results are all invented for teaching. This shows how a written plan can be built and tested. It is not a recommendation, and nothing here says how often this idea works.
Try it on a real chart. Test this idea yourself on past sessions with bar replay. Keep your own count, including the days with no trade.
The idea. A bull call spread buys one call and sells a higher one. The most it can lose and gain at expiry are known when it's opened (this lesson). John only opens one when the cost is less than 45% of the distance between the strikes.
John's plan (Harbor Index ETF at $100)
- Enter if
- the 100/102 call spread costs $0.90 or less. Buy 1
- Wrong if
- the whole cost is the planned loss
- Manage
- close at $1.90 or more, or let it expire. Close before expiry if the short call is in the money
- Risk
- cost $80 + commissions
Three outcomes
-
Worked: ETF $102.50 near expiry, spread closed at $1.95 → +$112.40
-
Failed: ETF $99.50 at expiry, spread worthless → −$81.30
-
No trade: the spread cost $1.05, more than 45% of $2.00 → $0
Show the full replays
| Replay | What happened | Result after costs |
|---|---|---|
| A | Bought the 100/102 spread at $0.80. Two days before expiry, ETF $102.50: closed at $1.95 | $115 − $2.60 (4 legs) = +$112.40 |
| B | Bought at $0.80. ETF $99.50 at expiry: both calls expire worthless | −$80 − $1.30 (2 legs) = −$81.30 |
| C | The spread cost $1.05 | $0 |
Test it yourself
- Work out the maximum loss, maximum gain and break-even before each trade.
- Replay the same idea with the plain call and with the spread. Compare the results.
- Learn your broker's assignment rules for the short leg (Exercise, Assignment and Settlement: What Happens at Expiration).
Where it breaks
- Values before expiry depend on time and volatility, not just the price.
- The short call can be assigned early.
- The spread caps the gain, so a big move earns no more than $1.20.
Reflection question: Before your last options trade, did you write down the most it could lose and gain?
Check yourself
- Keep the original separate 50/55 call debit example with $2/share debit. What are gross maximum gain, maximum loss and BE for a matched 100-share pair? Hint: width minus cost.
- Why can the debit example’s chosen post-exercise sequence lose $750 without contradicting its $250 diagram limit?
- What risk can the short option add before expiry? Does early put assignment mean the long put disappears automatically? Hint: assignment.
- What changes when fixed $4 whole pair costs are included?
- Why is the gain of the intact matched vertical capped? Hint: the sold option.
Reflect on your own process
- Does your written plan say what you will check if only one leg of a spread is exercised or assigned?
- When you log a spread, do you record both the intact expiry limits and the costs that shift them?
- How would you confirm your broker's handling of a spread near expiration before relying on the payoff diagram?
- Before your last options trade, did you write down the most it could lose and gain?