Most traders stick to predefined strategies like vertical spreads or iron condors. But what if your market view doesn’t fit into those molds? Is there a way that you can trade, but have the parameters of the strategy fall more into line with your specific market outlook, risk tolerance, or overall goals?
Why settle for cookie-cutter strategies? Custom option spreads let you fine-tune risk, reward, and probabilities to your exact outlook. In this article, we’ll show you how to build your own custom spread—and why it could give you an edge. Leverage the power of a customized spread strategy today!
What Is a Custom Option Spread?
A custom option spread refers to a personalized combination of long/short calls and puts with unique strike and expiration selections. These custom spreads are a unique profit-loss profile that is aligned with each investor’s specific risk tolerance and market expectations. The main appeal of using a custom option spread is that there’s much more flexibility in customizing the risk and reward aspects of the trade, which goes well beyond the benefits of using simple spread strategies.
Standard Spreads and Custom-Built Spreads Differences
How do custom-built spreads stack up against the standard ones that have predefined criteria? Once you understand these differences, it can be much more clear-cut when custom spreads make more sense than predefined ones.
Standard Spreads
- Execution is Simpler—These spreads come with a more straightforward profile for profit or loss. It makes them much easier to understand and to quickly implement—they’re generally used by new investors or those with little background knowledge before taking on more complex trading techniques.
- Customization is Limited—Unlike the custom-built strategies, the standard spreads leave little to no room for the flexibility to adjust the details of the spread. As stated, they’re a more straightforward approach, and traders have less room to work them around their specific market outlook or risk tolerance.
- Go-To, Classic Strategies—Perhaps the most notable aspect of these spreads is that they are classic trading techniques and strategies that appeal to a wide range of investors, such as the bull spread and bear spread, as well as the iron condor or butterfly.
Custom-Built Spreads
- Execution is More Complex—Custom-built spreads involve taking the standard spreads and building them around your specific trading goals, market outlook, and risk tolerance, so they require a deeper understanding of trading strategies, market dynamics, and options theory. These spreads are ideal for seasoned, experienced traders.
- More Customization—Because these spreads can be more easily adjusted, traders can experience a higher degree of flexibility in their trading sessions. Custom-built spreads can have traders choosing from any combination of other option types or financial instruments.
- Tailor Your Strategy to Your Needs—Custom-built spreads only really work for traders or investors who have a deeper understanding of how the market works, and they can enjoy the benefits of working their spread to fit their specific outlook on the market, as well as their personal taste for risk.
Quick Examples
What do custom-built spreads look like in action? We’ve included a few examples to help you visualize how these spreads are formed and how they can benefit your overall trading approach.
Example 1: Buying a call diagonal and selling a farther OTM put to offset premium. Purchasing a long-term call option at a lower strike price while also selling a short-term call option at a higher strike price is a good example of a custom spread that aims to profit from the combination of premium income with a bullish trend.
Example 2: Crafting a volatility-neutral combo when earnings are near. This move is designed to profit from time decay, and it largely banks on the phenomenon that volatility tends to revert to its mean. The most common way for online options traders to create this custom spread is to form an “iron butterfly,” in which profits from the underlying asset remain within a specified price range.
The Case for Customization
Why use a custom-built spread when trading online options? We’ll present our case for why you should use a customized approach to building your spreads and who this approach might appeal to the most. Consider this the best reason to choose custom-built strategies over traditional spreads.
- Tailored Risk/Reward: Adjust strike prices to suit your forecast with custom-built spreads. Standard spreads don’t let traders automatically adjust strikes unless it’s closing one and opening a new one with different strikes. Custom-built spreads let the trade wider or narrow the spread between the long and short positions to reflect their market outlook, be it bullish, bearish, or neutral.
- Fine-Tune Breakeven Points: The breakeven point for an option trade is the price of the underlying asset where the option contract is neither going to turn a profit nor result in a loss. Custom spreads do a much better job of fine-tuning the breakeven points of the trade, so investors can better assess potential risks and rewards that come with the spread.
- Capitalize on Skew and IV Differences: Custom spreads can better help traders take advantage of skew, the difference in IV between options with the same expiry but different strike prices. Taking advantage of this aspect of your trade will open up the door for more opportunities to turn a profit.
- Hedge Existing Positions with Precision: Custom-built spreads carry the advantage of being used for hedging against downside risk where traders can ultimately limit their portfolio losses. It’s cheaper to hedge with custom spread compared to buying individual stocks or options, plus the max loss is known ahead of time, which provides a degree of certainty before you even begin hedging.
Key Ingredients for Building Your Own Spread
What are the ingredients that go into developing a custom-built spread? We’ve outlined the main structure of these spreads to give you a good idea of the multiple parts that make up the entire picture.
- Directional Bias: One of the major components of a custom-built spread is your current outlook on the market. It’s your assumptions about market movement due to expenses or any relevant news releases that could have an impact on option prices. A bullish outlook is where you’re expecting prices to rise, while a bearish outlook is where there’s an expectation of falling prices. Neutral outlook is where you’re expecting prices to remain right around where they currently stand.
- Timeframe: Think about how long you’d like your trade to be by setting up an expiration date. You could choose a shorter expiration date to take advantage of a short-term swing (profiting from price speculation), or you could go with a longer expiration date to execute a long-term macro play.
- Volatility Outlook: Another important part of building your spread is taking future volatility into consideration. Is volatility expected to rise, fall, or stay put? Depending on the answer, traders can develop spreads that incorporate trades that take advantage of and profit from volatility. For instance, long straddles or strangles can profit from long volatility, or credit spreads can profit from decreasing volatility.
- Strike Selection: Another core component of the custom spread is the strike price. Is the trade going to be profitable being at-the-money (ATM), in-the-money (ITM), or out-of-the-money (OTM)? It largely depends on what other trades are being incorporated into the spread, so choose wisely.
- Expiration Choices: Obviously, you have to choose an expiration date for your custom-built spread. When you’re talking about a calendar spread or a credit spread, you’re dealing with a standard spread where the expiration dates are the same. Compare it to a diagonal spread (a custom-built spread) where you can choose two different expiration dates.
- Capital/Risk Tolerance: Based on how much money you’re willing to stake on your custom spread, choose an amount that you’re comfortable with putting up in the hopes of achieving the profit you’re looking for.
Step-by-Step: Building a Custom Option Spread
If you’re new to designing and building your custom spreads, we completely understand if you don’t know where to begin or how to get started. We’ve outlined this step-by-step guide to building your first custom option spread for your convenience.
- Step 1: Define your market view. This is your prediction of how a specific market or industry will perform in the future. Do you feel bullish or bearish? Or do you expect the prices to stay the same? Build a strategy around your market expectations.
- Step 2: Choose the core leg. This is typically a long call or a long put. It serves as the first part of your custom spread.
- Step 3: Offset risk/cost by adding short leg(s). This forms the second half of your custom spread.
- Step 4: Simulate the profit/loss profile using an options calculator. This will show the possible revenue from the spread minus any costs and expenses associated with building the spread. This would include the premium paid to enter each position, as well as any fees or commissions your broker app might charge for its services.
- Step 5: The next part of the process is to evaluate risk-to-reward using the R/R ratio. This is calculated by dividing the potential profit by the potential loss. It’s used to help traders decide if the trade is worth taking.
Traders and investors should also figure out the breakeven point and the maximum gain or loss potential. You can find out how much your spread can earn in profit, as well as how much it could possibly run you in losses if the trade doesn’t go your way. - Step 6: After all this is set up, the trader submits their custom spread and monitors its progress. They should keep an eye on the Greek metrics to see if they need to make modifications to their trade with time.
3 Real Examples of Custom Spreads
What does a custom spread look like using a real-world example? We’ve outlined three possible spreads that serve as good illustrations of what custom spreads are all about. Let’s take a look at a custom spread that takes advantage of a positive earnings announcement, a skewed exploitation move, and a hedged income generator.
1- Custom Earnings Play
A bullish spread that generates profit from an earnings report while also hedging against possible IV crush involves buying a long call option and hedging it with a short call or put. The goal with this custom spread is to profit from a positive earnings announcement and the price increases that are expected to happen, but also to profit from possible decrease in the option premiums when IV crush occurs.
A bullish spread with IV crush hedge will be made up of a long at-the-money call option (profits from the stock price increases upon earnings) combined with a short out-of-the-money call or put (offset for possible IV crush losses).
2- Skew Exploitation Spread
The skew exploitation spread consists of selling a high IV call and buying a low IV put. This kind of spread can be a great move for traders or investors who are expecting a decrease in market volatility.
Selling the Expensive IV Call
Traders will receive a premium for selling a call option with a strike price that’s slightly above the current market price of the underlying asset. Plus, they would be selling the call in the hopes that the underlying asset’s price doesn’t move significantly.
Buying the Cheaper IV Put
Traders might buy a put option as a part of their custom spread because they believe that the stock prices are going to fall. Not only is the lower premium more attractive for the buyer, but it’s indicative of a market environment where volatility is on the downturn.
3- Hedged Income Generator
A customized collar with wide wings is composed of a long stock, a short OTM call option, and a long OTM put option. The call and the put would have the same expiration date. This is called a “hedge income generator” because the collar’s long put would act as a hedge for the long stock, while the short call would help to finance the long put.
Tools to Help You Design Custom Spreads
Let’s take a look at some of the best tools that can help you design your next custom spread, simplifying the process and helping you create an effective spread that’s likely to help you turn a profit.
- Options Strategy Builder—This tool helps traders create, analyze, and visualize different options strategies to form the best-customized spread possible. Strategy builders are great for finding the ideal strike prices, expiration dates, and position sizes for your spread, saving you the time to perform complicated calculations.
- Payoff Diagram Generators—Traders can use these tools to visualize the potential profits and losses of a specific strategy upon its expiration date. You can learn the potential outcomes in different market conditions. The main appeal behind using these payoff diagram generators is to manage risk better and make better trade decisions.
- Implied Volatility Analyzers—These can be used to assess the market’s expectations for future price movements of the underlying asset, and they’re based on the options contract’s prices. It’s a tool that can be used to translate option prices into a measure of expected volatility.
- Options Chain Analyzers—Traders or investors can use this tool to analyze the available options contracts for a specific underlying asset. Traders can assess market sentiment while also pinpointing the best profit opportunities.
- Paper Trading Platforms— Another useful tool to use while designing your custom spreads are paper trading simulators, which can be used to backtest your ideas before staking real money in a live market.
Risks and Mistakes to Avoid
When putting together custom spreads, traders can run into some issues as far as big risks or careless mistakes go. If you want to have success with making money on custom spreads, we’d recommend trying to get into the habits and practices that keep you from making these common mistakes or taking on any unnecessary risks.
- Too Many Legs—Having too many legs on your custom spread can make things needlessly complicated for the trader. The best approach is to stick with two legs to keep things simple, though you can technically go up to four legs for moves like condors or butterflies. More often than not, it’s best to stick with just a few legs.
- Not Understanding Assignment Risk—There’s the chance with any trade that the buyer could exercise their right to buy or sell the underlying asset at the strike price, which would force the seller to fulfill their obligation. Many sellers get into traders not understanding this as a possible outcome and are then caught off guard when they’re required to fulfill the terms of the contract.
- Poor Liquidity and Wide Bid/Ask Spreads—Traders can make the mistake of choosing options for their spread that don’t have the best level of liquidity, meaning that they can be super difficult to buy or sell quickly/easily without affecting the cost of the underlying asset. Poor liquidity can be signaled through wide bid/ask spreads, traders should stay away from those types of options when designing their spreads.
- Misjudging Implied Volatility—Traders who don’t understand implied volatility or misjudge the role it can play in options trading. This mistake can lead to traders or investors overpaying for options or missing profitable trades.
Ready to Go Beyond Basic?
Creating custom spreads gives you an edge most traders overlook. With the right tools and planning, you can tailor every trade to your exact view of the market. Remember the main perks of using customized spreads compared to the standard spreads that are better suited to traders with lesser experience:
✅ Custom spreads = personalized risk/reward
✅ Ideal for advanced setups, earnings plays, and skew trades
✅ Use simulation tools to validate your plan
✅ Keep it simple and liquid—don’t overbuild
✅ Practice before going live
Try our Free Options Strategy Builder Tool to create and simulate your own custom spreads today.
