confused about spreads???

Question

can u explain the different kinds of spreads and what they are used for. i know they reduce risk, but dont understnad exactly What they do.

Answer 1

Let me start by showing you how a spread can lower risk. I will use a simple vertical spread in this example.

Assume a stock is selling for $50.00 per share and I expect the price to go up. I can sell a put with a strike of $50 for $5.00 per share ($500 per contract) and, if I am correct and the price does go up, that money will be mine to keep. However, if the stock drops sharply I can lose much more than that amount. For example, if the stock drops to $30 per share I will lose $15 per share ($1,500 per contract) on the option trade.

I can reduce that risk with a spread. Instead of selling one $50 put contract for $500, I could sell two $50 put contracts for $1,000 and buy two $45 put contracts for $2.50 per share (or $250 per contract) paying $500. That would leave me with a net credit of $500 with will give me the same $500 profit if the stock goes up. However, if the stock goes down the most I can lose is $500.

Explaining all the different kinds of spreads would take more space than allowed. You can find a lot of them at

http://www.theoptionsguide.com/strategy-index.aspx

Answer 2

Bid-ask spread: The difference between the prices offered by buyers and sellers. If you sell, you get the lower sell price. If you buy, you pay the higher buy price. The "market maker," the trader on the floor of the exchange pockets the difference