2 mins read

Forward Spread

Definition:

A forward spread is a type of options spread that involves selling one call option and buying one put option with the same strike price, but at different expiration dates.

Structure:

  • Sell one call option: This creates a credit spread, which generates premium.
  • Buy one put option: This creates a debit spread, which costs premium.
  • The strike price of both options is the same.
  • The expiration dates of the options are different, with the call option expiring earlier than the put option.

Characteristics:

  • Profit potential: Unlimited, but limited to the credit received for the call option.
  • Loss potential: Unlimited, as the price of the underlying asset can move against you in either direction.
  • Net credit: The net credit received from selling the call option less the net cost of buying the put option.
  • Probability of profit: Higher than a regular spread, as the call and put options have a higher probability of expiring at their respective strike prices.
  • Time decay: The value of the spread decreases over time, as the options approach expiration.

Uses:

  • Neutral to bullish outlook: Forward spreads can be used to profit if the market remains at or near the strike price.
  • Hedge against downside risk: They can be used to limit losses on a short position.
  • Speculation: Forward spreads can be used for speculation, as they have the potential for high returns.

Example:

Sell one call option at strike price $50, expire in one month.Buy one put option at strike price $50, expire in three months.

If the market price of the underlying asset is $50 at expiration, you can exercise the call option and buy the asset at $50. If the market price is below $50 at expiration, you can exercise the put option and sell the asset at $50.

Note:

Forward spreads are not recommended for beginners, as they have a higher risk profile than other options strategies.

Disclaimer