Horizontal Spread

A horizontal spread happens when you buy an option and sell an option on the same stock with the same strike price, but with different expiration dates.

For example say it is February and we find a stock we want to place a horizontal spread on.

We buy the March $70 call for $7 and

Sell the February $70 call for $5

Max Profit

The most we could make is the combined sum of the options we sold, in this case $5 and what we sold the last month option for.

So if we sell this and the stock doesn’t make a big move we might be able to sell the March Call for another $5, or maybe even more. In this case we made a total of $10 but spent $7 to do it.

Max Loss

The most we could lose is the difference between what we sold the call for and what we bought the later month call for.

We would lose money if the stock goes up too fast on the first month and goes above $70. If that happened we would buy the stock at $70 and sell it at $70 but we would be out of the position for a loss of $2.

We could also lose money if the stock falls too fast. If the stock falls so far that the March $70 put isn’t worth that much we could also lose money.

When to Sell Them

You can sell a Horizontal spread when you aren’t expecting the stock to make a big move. If you believe the stock will stay range bound for a while it is a good method to produce a monthly income.

However there is risk. If the stock does not stay range bound and ends up making a big move downward you may not be able to recoup your initial investment by selling the call option.

For instance we shall say the stock drops during the first month and we can only sell our March call options for $1 now. In this case we only made $5 from February and $1 from March for a total profit of $6, but we spent $7 to do that so we actually lost money.

The other risk is that the stock moves up a lot during the first month. If this happens you will get called out of the February option and will be able to use the March option to buy the stock for you. In this situation you were only able to sell 1 month’s call option for $5 and since you spend $7 on the March option you would be down $2.

That is why this trade is best made for a stock that is likely to stay sideways for a while.