8.4 Spreads & Straddles
Spreads and straddles represent the most mathematically tested section on the Series 7. Master the DEW vs CEN mnemonic and straddle double-breakeven calculations.
Key FINRA Exam Takeaways
- Spread: Simultaneously buying and selling options of the SAME CLASS (Call Spread or Put Spread).
- Vertical (Price) Spread: Different strikes, same expiration. Horizontal (Calendar) Spread: Same strike, different expirations.
- Debit Spreads (Bull Call, Bear Put): Net buyer. DEW Rule: Debit - Exercise - Widen. Max Loss = Net Debit.
- Credit Spreads (Bull Put, Bear Call): Net seller. CEN Rule: Credit - Expire - Narrow. Max Gain = Net Credit.
- Long Straddle: Buy Call + Buy Put (same strike & expiration). Bet on massive VOLATILITY in either direction.
- Short Straddle: Sell Call + Sell Put (same strike & expiration). Bet on market STABILITY / zero movement.
Debit vs. Credit Spreads (DEW vs. CEN)
DEW: Debit spreads are established for a net debit; the investor wants the options to EXERCISE and the spread difference to WIDEN. Max Gain = Difference in Strikes - Net Debit. CEN: Credit spreads are established for a net credit; the investor wants the options to EXPIRE and the difference to NARROW. Max Loss = Difference in Strikes - Net Credit.
Straddle Double Breakevens
A Long Straddle has TWO breakevens: Upper Breakeven = Strike + Combined Premiums. Lower Breakeven = Strike - Combined Premiums. The stock must move outside these bounds for the position to be profitable.
Bull Call Debit Spread Breakdown
An investor buys 1 XYZ Nov 40 Call at 5 and sells 1 XYZ Nov 50 Call at 1.
- Step 1: Net Debit = $5.00 paid - $1.00 received = $4.00 net debit ($400 max loss).
- Step 2: Strike spread = $50 - $40 = $10.00.
- Step 3: Max Profit = Strike Difference ($10) - Net Debit ($4) = $6.00 ($600).
- Step 4: Breakeven = Lower Strike ($40) + Net Debit ($4) = $44.00.
An investor establishes the following position: Buy 1 ABC July 65 Call at 6; Sell 1 ABC July 75 Call at 2. What is the investor's breakeven price and maximum potential profit per share?