Understanding Options Spreads: A Beginner's Guide

Options allow flexibility in investing but are some of the most risky instruments, that's why you should be aware of spread options. An options spread allows the investor to absorb major losses and aligns the investor with his or her view of the market.

For instance, a spread on the Euro will allow the investor time and position to realize his or her view of the market. If the investor sold the front month and bought the back month (ie. sell July'10 and buy Dec'10) he or she would benefit from a drop in the Euro. Since it's a spread option there are more complexities, so selling the July'10 option gives a lot of benefits for the time value decay as the option approaches expiration, a major drop in price will afford the investor a lot more gains quickly.

Keep in mind, the investor also can buy the July'10 leg when he or she feels the market has reached a cyclical low then hold on to the Dec'10 expiration option for profit. Spread options are more difficult than the futures spread because the option is a more complex derivative. Check for analytical values; such as delta before placing the spread trade.