How to handle vertical spread expiration? Practical case analysis
Vertical Spread is a strategy that combines two options with the same strike date and the same type (both call or put), but with different strike prices. By buying and selling two option contracts, investors limit returns and risks, so that profits and losses are fixed within a certain range. According to different directions, vertical spreads can be divided into Bull Call Spread and Bear Call Spread.
At expiration, the settlement of the vertical spread follows standard option exercise principles. The system will determine whether each Leg (Leg) is In the Money (In the Money) or Out of the Money (Out of the Money) based on the maturity settlement price of the underlying asset: if the option is Out of the Money, it will automatically be invalidated; If it is in the price, it will be automatically exercised or settled in cash. When both legs are in the money, the system automatically netts based on the strike spread. The entire process does not require manual intervention by investors.
1. Settlement principle
At expiration, there are three situations in which the vertical spread combination occurs:
Both legs are extra valent: Both options expire at the same time, no operation is required, and investors retain all received premium.
Within only one leg price: One leg in the money will be exercised or settled in cash, and the other leg will be invalidated, resulting in partial gains or losses.
Both legs in price: The system automatically hedges the two-legged exercise, and makes cash settlement according to the price difference between the two exercises, and investors get or pay a fixed difference.
The advantage of the vertical spread strategy is that investors can clarify the maximum profit and maximum loss ranges when opening a position, and automatically settle the maturity, so there is no unlimited risk.
2. Alibaba's practical case
Suppose an investor establishes a Bear Call Spread on an option expiring on October 3: sell BABA 1003 185 CALL, buy BABA 1003 190 CALL
SELL BABA 1003 185 CALL (Take premium)
BUY BABA 1003 190 CALL (Pay premium)
Net receipt of premium $104 (100 shares per contract)
The core logic of the combination is to bet that Alibaba shares won't break through $185 sharply at expiration. If the price remains below $185, investors will receive all premium gains; If the stock price rises sharply above $190, the loss is limited to the spread between the two strikes minus the received premium.
3. Settlement results under different maturity prices
1.BABA ≤ US $185
Sell 185 CALL: Extra-price, invalid
BUY 190 CALL: Extra-price, invalid
Processing method: The system is automatically invalidated without operation
Profit and loss: Get all premium rights+104 USD(Maximum profit)
2.185 < BABA < $190
Sell 185 CALL: Within the price, the buyer will exercise the right → you need to fulfill the obligation
BUY 190 CALL: Extra-price, invalid
Processing method: Sell the leg for cash settlement or delivery according to the difference
Profit and loss calculation formula：
Profit and Loss = − (BABA closing price − 185) × 100 + premium received 104 Profit and Loss
illustrate: due BABA = 187
SELL 185 CALL: 187 − 185 = 2 × 100 = $200 Loss
BUY 190 CALL: Void = 0
Net profit and loss = 104 − 200 =− $96
3. BABA ≥ $190
Sell 185 CALL: In-price
BUY 190 CALL: In-price
Processing method: The system automatically exercises both legs → hedging settlement, loss cap
Maximum loss calculation：
Maximum loss = (190 − 185) × 100 − 104 = 500 − 104 = $396
Description: This is the upper limit of loss and will not be increased
4. Profit and loss summary
Maximum profit: $104 (when BABA ≤ $185)
Maximum loss: $396 (when BABA ≥ $190)
Breakeven: 185 + (104 ÷ 100) = $186.04
Maturity processing: The system automatically settles, out-of-the-money legs are invalidated, in-the-money legs are exercised or cash hedged, no manual operation is required.
5. What is the impact of being exercised in advance?
If the Put option is exercised, you may need to deliver or buy the stock, but the protection option you hold (buy the high strike price Call/Put) is still valid, hedging the loss.
The upper and lower limits of profit and loss are determined by the exercise spread and net premium of the two options, and will not change due to early exercise.
VI. Conclusion
The advantages of the vertical spread strategy are:
The maximum return and maximum risk are locked when opening a position;
It is suitable for investors who have judgment on the underlying price range but want to control risks.
In this example, a bearish vertical spread consisting of selling BABA 1003 185 CALL and buying 190 CALL can earn the full premium gain when the BABA stock price is below $185; If the stock price rises sharply by more than $190, the loss is limited to $396. This strategy is especially effective in volatile or slightly downward market conditions, and can achieve stable returns under limited risks.
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
