A Vertical Spread is an options spread in which one option is bought and one option is sold, where both options are of the same type (put or call), have the same underlying security, and expire at the same time, but have differing strike prices.

The two most common types of vertical spreads are the Bull Call Spread and the Bear Put Spread.

Bull Call Spread

A Bull Call Spread is the purchase and sale of call options at different exercise prices but with the same expiration date. The purchased (or long) calls have a lower price than the written (or short) calls. The investor expects a rise in the price of the underlying asset.

Example:
XYZ Stock @102.50
Buy 1 XYZ Apr 100 Call @ 9
Sell 1 XYZ Apr 110 Call @ 5
Net Cost 4

Max Risk: 4 (the net premium paid)
Max Gain: 10 - 4 = 6
Break-even (at expiration): 100 + 4 = 104
Loss if stock is unchanged = 1.50
*-4 (cost of spread) +2.50 (value of spread @ 102.5) = -1.50

Due to the fact that bull call spreads have limited risk, they have limited profit potential. It’s obvious to say that the higher profit potential you have in anything you do, the higher the risk associated with it is. The most appropriate time to pursue a bull call spread would be when the market forecast points to a moderate stock price rise.

Bear Put Spread

A Bear Put Spread is the purchase and sale of put options at different exercise prices but with the same expiration date. The puts purchased have a higher exercise price than the puts written. The investor expects a fall in the price of the underlying asset.

Example:
XYZ stock @ 63.75
Buy 1 Jan XYZ 65 Put @ 5.50
Sell 1 Jan XYZ 60 Put @ 3.25
Net cost 2.25

Max Risk: 2.25 (the net premium paid)
Max Gain: 5 - 2.25 = 2.75
Break-even (at expiration): 65 - 2.25 = 62.75
Loss if stock is unchanged = 1.00
*cost of spread - value of spread @ 63.75 = 2.25 - 1.25

Similar to the Bull Call Spread, the Bear Put Spread has limited risk associated with its limited profit potential. The most appropriate time to pursue a bear put spread would be when the market forecast points to a moderate stock price decline.