Using Horizontal Spreads
Options spreads can be categorized in a number of different ways. One of the main categories is based on the direction of spreads and there are three types in this category: vertical, horizontal, and diagonal. Horizontal spreads are those that consist of options contracts of the same type, on the same underlying security, and the same strike price: but they have different expiration months.
The options involved appear along the same horizontal line on an options chain, which is what gives these spreads their name. On this page we provide more detail about horizontal spreads and their use in options trading.
Please be aware that horizontal spreads can also be put in the category of calendar spreads. However, as not all calendar spreads are horizontal, the purpose of this page is to clearly define exactly what makes a horizontal spread and the advantages and disadvantages they offer.
All spreads are basically a form of options trading strategy, so for more detailed information on how horizontal spreads and other types are used, we would strongly recommend visiting our section on Options Trading Strategies. This section contains all the different types of options spreads with more details on how they can be used in the various strategies that you can employ.
Creating Horizontal Spreads
A horizontal spread is basically created by writing options contracts of a particular type and buying contract of the same type but with different expiration months. For example, you would first use a sell to open order to write contracts of a certain type with an expiration date of, et's say for example, June. You then use the buy to open order to buy contracts of the same type but with an expiration date of the following February for example. You can use calls or puts.
As mentioned above, horizontal spreads were named as such because the contracts involved appear along the same horizontal line in an options chain. If you are not familiar with options chains, we would recommend that you read this page, as this explains how they work in more detail.
Advantages & Disadvantages
The principle behind horizontal spreads is based on how time decay affects the value of options contracts. As a general rule, short term options have a higher rate of time decay than long term options. So by making more in time decay through the short term options you write than you lose in time decay through the ones you buy you can make a positive return. The longer term contracts also have the benefits of reducing the margin requirement of the short position and offsetting the potential losses should the underlying security involved move significantly.
For example, if you have created a call horizontal spread and the underlying security increases in price, you stand to make losses if the holder of the contracts you have written decides to exercise. However, you could choose to exercise in the contracts you have bought to offset those losses. This is a clear advantage of creating a horizontal spread rather than simply taking a short position by writing options contracts.
The downsides include the increased commissions involved due to the extra trade of buying contracts as well as writing them. Profits are also limited. If you have created a call horizontal spread,] and the price of the underlying security does fall, then the profits you have made from writing the calls will be reduced by the cost of the calls you have bought.