Vertical Spread Strategies
You have an advantage when offsetting long and short positions.
Smart Investor TipAs with most option strategies, time value spells the difference between profit and loss in most spreads.
Whenever you combine a long call with a higher-strike short call, you create an alternative form of "cover" for the short position. The risk disappears as long as both positions are open because, even with a large price run-up in the stock, the long position is always going to be worth more than the short position. This remains a covered position as long as the long position is open. However, if the long call expires and the short call remains open, it reverts to an uncovered position. So the safest covered spread of this type exists when both expire at the same time (or when the long position will be open longer than the short).
It is also possible to create a covered put using the same strategy. It involves creating a spread in which the long position has a higher strike than the short put position. If the stock's value falls so that the short put is in the money, the long put will also be in the money and will always be worth more. This is true as long as both puts expire at the same time, or when the long put remains open longer than the short put. This is the only situation in which a short put can be truly covered. In "Selling Puts: The Overlooked Strategy", the many strategies involved with the selling of puts demonstrated why puts cannot be covered in the same manner as calls; but in a put-based spread, you can overcome this limitation and create a low-risk strategy.
By Michael C. Thomsett