Options Trading Tutorial

What is the difference between creating a spread and simply writing options?

My broker has 2 different option trading levels: 1 - writing covered calls, writing cash secured puts 2 - creating spreads (requires a margin account) What is the key difference between those two if I can basically create a spread using level 1?

Public Comments

1. <<<My broker has 2 different option trading levels:>>> I strongly suspect your broker has more than two option trading levels. There is almost certainly a trading level that allows someone to buy naked options, as well as a trading level than allows someone to sell naked options. <<<1 - writing covered calls, writing cash secured puts>>> A covered call is the synthetic equivalent of a cash secured put. They are slightly less risky than simply owning the underlying risk, but they also severely limit the maximum amount you can make. <<<2 - creating spreads (requires a margin account)>>> A spread consists of offsetting positions on the same (or very similar) underlying stock. Most, but not all, spreads have limited risks and limited rewards. In other words, there is a usually strict limit on the most you can lose and the most you can make. with a spread. You will have to check with your broker to be sure, but there is a good chance that the types of spreads you can trade will be limited to exclude spreads that can have unlimited losses. (An example of a spread that can have an unlimited loss would be a call ratio spread, such as buying 2 calls with a lower strike price and selling 4 calls with a higher strike price.) <<<What is the key difference between those two if I can basically create a spread using level 1?>>> First, you can only "basically create a spread using level 1" if you can also buy options.and you can only create a spread with a short call if you sell a stock short. Second, you will require a lot of cash for creating a spread using level 1. For example, assume you want to open a long butterfly spread using strikes of $90, $100 and $110. Let's assume the premium for a $90 put is $2, the premium for a $100 put is $5, and the premium for a $110 put is $12. To open this as a spread it would cost $1,200 + $200 - $1,000 = $400. To open the same spread using level 1 you would also have $20,000 in cash tied up to secure to the short puts, for a total of $20,400.The maximum profit possible from the spread is $600. That means the maximum profit you can make is 150% of the cost of opening the spread using level 2, but less than 3% of the cost of opening the spread using level 1.