Analyze Vertical Spreads with the Risk Profile Tool
The following content is intended for option traders with substantial options knowledge. If you're not familiar with options, please review our options content for beginners available to Schwab clients.
The Risk Profile tool on the thinkorswim® platform can help traders analyze potential trades. The tool provides a single visual risk snapshot that helps traders estimate changes in a trade's profile given certain changes in risk components like time and volatility. From the basic long call option to a complex multi-leg ratio spread, the Risk Profile offers a versatile approach to options analysis.
One example of a more complex trade is the vertical spread1—the purchase of a call or put option paired with the sale of another call or put of the same expiration month but with a different strike. Let's review how the Risk Profile tool can help you analyze vertical spreads.
Building a vertical spread with the Risk Profile tool
From the Analyze tab, select Add Simulated Trades and enter the desired ticker symbol. Right-click a strike that should be analyzed as part of the vertical spread, and then select Analyze buy trade or Analyze sell trade, depending on your preference. This will bring up a menu of spread choices. From here, select Vertical.
Source: thinkorswim platform
For illustrative purposes only. Past performance does not guarantee future results.
As an example, let's analyze selling the 105–100 vertical put spread, which is the sale of the 105-strike put and the purchase of a 100-strike put. In this example, a trader is selling the spread for a credit of $0.61 (times the options multiplier of 100, that equals $61 minus transaction costs).
To get the visual display of the simulated trade, under the Analyze tab, select the Risk Profile subtab (right next to Add Simulated Trades). There's a chart of potential outcomes for the trade. This is an estimation based on theoretical values. Trades in the real market might perform differently.
Source: thinkorswim platform
For illustrative purposes only. Past performance does not guarantee future results.
Understanding the scenarios
The blue line in the chart represents the trade's profit and loss (P&L) at expiration, which has two sharp angles. Those angles are the strike prices of the spread. The purple line is the estimation of the spread's P&L as the price of the underlying changes. For instance, if the underlying were to go to $107 today (highlighted by the number 1 in the chart), the trade would be down about $47. But if the underlying remained at that level until expiration (2), the trade could end up making $61. Both legs would expire worthless, and the trader would keep the premium minus transaction costs.
The chart demonstrates how the passage of time helps this trade if the underlying stays above the high strike of 105. However, if the underlying drops to $96 today (3) and stays there until expiration (4), today's loss of about $300 would become a full loss of $439 by expiration. If both strikes finish in the money (ITM)2, the trader is assigned a long stock position at $105 per share and the 100-strike put will be exercised, selling the stock at $100 per share and resulting in a $5 loss. But if the trader collected a $0.61 credit when selling the spread, the net loss would be $4.39 times the contract multiplier of 100, or $439, plus transaction costs.
Traders can also analyze the trade using other future dates prior to expiration and at other levels of implied volatility3 by using the Lines and Step buttons.
No matter the positions within the same stock and the complex layers of the trade, the Risk Profile tool provides information a trader can use to make decisions.
Keep in mind
- While P&L calculations assume options positions will be held until expiration, traders can usually close long or short options positions prior to expiration by buying or selling them in the market.
- All probability calculations are based on an assumption of stable, implied volatility values. Changes in implied volatility could dramatically affect forecasts.
- Delta, which estimates the probability of change in an options price relative to changes in its underlying stock, is often used as an instantaneous forecast of the approximate probability of an options contract expiring ITM. Just keep in mind, delta is calculated continuously, so it'll generally increase or decrease as the underlying stock price changes.
- The projections and forecasts generated by the Risk Profile tool are hypothetical in nature and should not be regarded as indicative of actual investment results.
- Trading and investment decisions should not be based solely on values or calculations generated by the Risk Profile tool.
1An options position composed of either all calls or all puts, with long options and short options at two different strikes. The options are all on the same stock and of the same expiration, with the quantity of long options and the quantity of short options netting to zero.
2Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.
3The market's perception of the future volatility of the underlying security directly reflected in the options premium. Implied volatility is an annualized number expressed as a percentage (such as 25%), is forward-looking, and can change.