 Hey there X traders and welcome to today's video. It's going to be hopefully smaller than previous videos because it's a very complicated topic. So what I decided to do was split this up into the main topic is of course spreads and I said in the previous video where I covered one-on-one trading in a visual format which I'm going to link to right here that spreads are sort of complicated although I do believe that people make it out more difficult than it really is. So what I'm going to do is I'm going to split this between basically the most basic type of spread which is a vertical spread which are going to be like these six slides right here and then in the next video I will go into basically the other type of spread which is one that includes the factor of time. So in the first six slides of this presentation which is going to be this video right here I will cover vertical spreads which is the simplest kind of spread and then in the second video it's going to be a two-part series. I'm going to talk about calendar spreads and basically the difference between these two is let's say it is mostly the time factor and then we'll get into why that is. So let's go ahead and dive right in. Don't forget to subscribe to our YouTube channel so you can get notifications on the latest videos on different topics that we cover in the the Xtrades community. They get posted on the Discord Xtrades community and you can also follow us on Twitter and I'll go ahead and leave all those links in the description below. So let's dive right into spreads. Okay so an incredibly quick recap of time decay in options. Basically time decay is or let's just say time is what makes options possible. Otherwise it wouldn't be I guess possible because the difference between stocks and options is that in stocks you get into a trade obviously buy low sell high and then you get out whenever you want to but with options you can't really get out whenever you want to. You have to get out before expiration which is marked here in bright danger precaution red. Okay so that is the main difference the biggest difference between stocks and options and options you have to get out before the ship sinks basically it always sinks. Time eventually runs out and you reach expiry and that is when the entire contract goes to zero which is why in the previous video which I linked to right here we talked about or we compared it compared options to a hot potato. Okay so basically somebody decides to take a guess on what the price of a stock is going to be in the future and there's two sides to every bet obviously there has to be a winner and a loser and basically the person who writes the option contract and then sells it of course is betting that it the option will be out of the money which means it won't be at that strike price at that expiration date and whoever bought the call which is obviously on the opposite side or believes the opposite is basically saying yes that stock will be at that strike price on that expiration. Okay so from then on it becomes this game of hot potato and one of the things that we must keep in mind is that the option price okay the value of the option is going to fluctuate obviously up or down and because from the moment it is conceived or you know created or written actually that option is the farthest from expiration that it can be so it is incredibly the unknown is let's say greater there are a lot of things that can happen between time zero and time expiry that will change the price of that option if it goes above the strike price then it increases in value if it goes below it decreases in value and a lot of things you know earnings economic data we covered this in this video here which is basic trading strategy things that affect the option price upgrades downgrades you know all of those things there are so many of those individual you know factors that could affect the price option and and basically they they are eliminated one by one as time goes by and the the closer you get to expiration then the more the more certain we are that the price is not going to deviate too much if the options the option price starts you know at 10 and that and then that option price is basically going to fluctuate between 10 20 you know 0 and then eventually 19 you know 2 18 5 and eventually it's going to land let's say that it is going to land at 0 then basically at expiration it's going to be somewhere between 9 and 11 okay so the closer you get the expiration the more we know with with highest precision what that price final price is going to be so that is what gives options their value basically the uncertainty of both parties the buyer and the seller of what the actual final price is going to be on expiration okay and the closer you get to expiration then it's easier to tell than who's going to be the winner okay and that is when that uncertainty basically flows out of the option and then that is also why the options value eventually drops to 0 because of that time decay the closer you get to expiration until it is worth actually 0 the slowest time decay happens the beginning and then the fastest time decay happens towards the end so when you buy an option it's going to rock it it probably going to rock it it's probably going to rock it more around near expiration date and which makes it more exciting to trade you can make a lot more money but it also makes it more dangerous because you can lose everything in a day and then the if you are a more conservative trader then you end up buying expiry if you're buying if you're longing options or calls or puts then you usually do that with 30 or more days to expiration which is when time to clay time decay is the slowest and this is probably more suited for those of us me included that are not so you know risky with our money and or with our trades okay so let's dive right into an example and we'll look at the simplest kind of vertical and which is sorry the simplest kind of spread which is the vertical spread okay so Boeing we all know or well maybe not all of this but Boeing was a very high flyer and up to a few years ago when they had some issues with basically the most important product line which was the 737 max and from that moment on the stock basically just tanked I believe the highest was around 300 somewhere up here or higher than this we'll look at the live chart in a minute and it has since tanked all the way down to below 125 as we can see here and it seemed to want to recover and then failed and then seemed to want to recover again it failed here it failed here again it seemed to want to continue to recover and it failed and then it mega failed and then it's super mega failed and now it's back up on track and it's trying to recover and then you know it has some failures obviously that obviously nothing goes straight up but it seems that it made a double bottom somewhere around here and as we know that is one of the bullish price patterns that we should all know about and it also seems to coincide with the basically the whole reopening trade you know after the pandemic there was also a lot of reason why some companies or in this case Boeing would recover it makes a lot of sense that it should so technically speaking we have a double bounce or a double bottom excuse me technically speaking we also have a recovery towards this area which is very important it was resistance here resistance here it was support here support here support and support again so this is obviously or undisputably a very strong area of reaction of price action and basically well is it going to recover well this is actually an older chart making this video on January 5th but this is I believe a November or possibly December early December Boeing chart when the price of the stock was actually around 179 you can see right here so it is below this you know this zone here and well basically what are we what we're going to do is we're going to look at how to take this vertical spread on a stock like Boeing okay so obviously we look at technicals we look at fundamentals when we talked about this recovery not only of the company solving its issues but also with the general market reopening for stocks such as this and and we you know we make sure to remind ourselves of some of those trading rules that we have and we come up with a trade plan okay so let's say that our price target is somewhere between 125 and 200 let's say that it's somewhere in between this area this general area right here okay so what would happen if you take a call a single or naked call it's called naked because you are basically not covered so that should give you an idea of what kind of trade this is it's obviously you know a dangerous trade because it's naked you know you're not covered okay so it is very directional it is the most directional type of trade because you are focused on this thing on this direction and you can see the max profit here as we mentioned before is infinite of course that never happens so don't get you know fooled don't be fooled by this because it's not really infinite it never is infinite which means that this is not real okay it is the riskiest it is the riskiest because basically your max profit is infinite but your max loss is also whatever you pay for it so you could lose everything okay if this one's only worth $985 but a $2,000 or a $5,000 call would mean that you are risking basically all of those $10,000 or $5,000 sorry so it is the riskiest it can go to zero in no time okay all right and but of course it has the largest reward but like I mentioned beware it's not infinite you're never going to get an infinite amount of money you're never going to get infinite minus x it's just not going to happen if anything you're going to get double digit returns percentage wise which means anywhere from 10 to 99% and max I would say 100% you know maybe I mean you do see trades that go to 300 and even 400 but they are very few and far between okay so that is what the naked call is basically telling us this is the break even 204 we're buying the 195 call but it cost us basically a thousand dollars or so okay so well it's actually 985 but this is our break even and we need this call to basically or the stock to be above our strike which is 195 according to the strike of the option that we're buying but remember the break even the break even is the strike price plus the cost which in this case is 985 dollars okay so that's very simple everybody knows long calls let's see what happens when you make it into a spread basically it's still directional but you are hedging or covering yourself in a way so that is no longer a naked spread you're not so exposed so how does that happen basically you limit your ward and you limit your risk so that's the trade off so let's look at the numbers now so now your max profit is not infinite that's fine it probably never was it's only 1285 dollars okay and your max loss so you've limited your profit from infinite down to 1200 but look at this you also limited your loss limited your risk down from 985 which is what the debit was that you were paying for that call to 715 why because you're actually how is it that you are reducing your exposure or your risk or your max loss or your debit because that 985 is being offset because now you are also selling a call you're not just buying a call so what you do is you still buy the call below the current price okay but you sell a call above the current price which is what this horizontal line does this horizontal line means that you are not going to profit above whatever this price level is here which is about 205 okay so you are only going to make from your break even to this 205 from the 192 to the 205 if it keeps going you're not going to profit from it okay that's not the case in the long call if you recall in the long call after 200 or after 195 you kept going and going and going and that's why max profit was infinite all right so here you're capping your reward you're capping your gain and in exchange for a limit in your risk you are reducing your risk from 985 to 715 okay and that is very easy to do you basically take whatever long call gets alerted to and you sell a call on a strike price above okay and there is some toying around with these strikes and that's the last thing we're going to look at in this video so originally the call was for 195 okay remember right here you're buying 195 so you're betting that this which is currently at 179 is going to reach 195 somewhere up here above this level okay now when you do the vertical spread you actually bring your 185 in and you open up to 205 so what have you done that means that now this thing could go anywhere between 185 which is lower than 195 and could go all the way to 205 so what you're doing is you're basically opening up how much you what zone you could be profitable in okay and we actually have another example which we'll look at right now in order to compare this we when we take the naked call we do a 195 okay when you do a spread you can bring this strike in which means instead of 195 you can buy 185 but what happens is the 185 is more expensive but remember why it's more expensive they're more expensive because they are more probable the delta is higher on the lower strikes for the calls well I just think about it it's a lot more likely that it's going to reach 185 being at 179 then it is likely that it's going to reach 195 so when you're buying singles you you pick your strike price and that's fine but when you're buying spreads okay you can lower that long strike from 195 to 185 which of course makes it expensive right but remember you're selling a call above so that gives you a credit so even though you you bought a lower strike which is more expensive your complete debit your net debit in the end is lower than the 195 call because you're selling the 205 strike against it okay and now let's look and compare with this other one this is basically a $20 wide strike because it goes from 185 to 205 that's a $20 difference right there here we're going to compare it to a $10 strike okay so you bring in the 185 to 190 and you bring down the 205 to 200 now let's look at what that actually looks like on here okay so that's our zone let's say and this is of course already in January so if we look back at this okay yep that was right here so that was early December okay when this was trying to recover back towards this towards this zone which is the zone that we are interested in as let's say that this is a magnet zone okay some people call it a demand zone a supply zone but it's basically a support resistance level which is wherever price reacts to a lot okay and I had this a little bit wider on the presentation but that's fine basically if this is headed back towards this zone which we were right here at the beginning of December then we're betting that this thing is going to go up to the zone and it might bounce back down or it might break through which apparently it broke through but back then you weren't sure so we're just betting on the fact that this thing is going to make it till 195 all right so what we want to do here is if I can find the rectangle to just give you an idea okay the first strike is 195 the first spread is 185 to 205 185 would be down here okay to 205 that didn't work I think it's one of those tap and release things yep to 205 would be right around here okay so that's how wide our first vertical spread is let's look at which one that is that one is this one right here okay from 185 to 205 that's a very that's a $20 spread we can make up to $1200 by risking $700 all right so that's about you know two to one now let's go ahead and look at the other one which was 190 so it's higher up 190 to 200 all right that's that right there okay so we have a much think of these as dartboards okay your strike has to land somewhere inside this dartboard okay obviously the bigger the dartboard then the more probable it is that you're going to hit that strike the smaller the dartboard the less probable now of course that's reflected on the probability on the profit okay so on this dartboard okay it's a bigger dartboard right it's 185 205 your profit is 1285 but on this board you only have you only have a $10 strike your max profit is only 642 all right but look at how again look at how much you're risking right so again the basic idea is that you are reducing your debit which means that you are reducing your max loss which means that you are limiting your risk and you are obviously capping your reward because above a certain level above that short strike you're not going to make any more money even if the stock keeps going up so that is basically the trade-off and that is what happens when you take a vertical spread now look at how this this went down basically from you risking a thousand dollars to you risking 350 dollars so this is a lot more palatable for a lot of a lot of traders especially more conservative traders okay so this is why we use spreads you want to take the 190 call that's what was alerted to but let me go ahead and sell a call above that so I'll profit from 190 all the way to 200 but after that I won't okay so let's go ahead and look at the comparison so we can end this video and I'll put the other one out next week so on the single you're risking 985 on the vertical wide we were risking 715 on the vertical tight we were working we were risking 350 dollars so that's a very nice comparison on on how a vertical spread can reduce your risk or your net debit or max loss or we want to look at it the reward on the single was infinite but really you know was it really infinite not not so sure about that not very likely on the wide vertical you have a smaller we reduce the entry we we are able to bring that entry down closer to at the money which makes it more probable right on the on the tight vertical in exchange we have this narrower range so it's a smaller debit but it's also a narrower range that you have compared to the vertical wide which has a wide range right okay and then obviously you have a a a much wider range in which it can be in the money so you want to buy in the money which is not necessarily the case in other spreads but you can you know that's the point you can buy in the money because you're selling that other call which reduces your entry your entry cost right and in the tight vertical well obviously it is a much it is a much smaller range but you can still buy in the money because it's a vertical and you can see the difference I mean we're talking 50 percent or sorry well yeah 30 percent or 100 percent difference between $700 and $300 $250 okay so this is why verticals are a lot more appealing okay and and for certain kinds of traders more conservative traders because you can go ahead and basically take a trade which is normally very expensive which means that it's very likely to be in the money because if you've noticed on the options chain the strikes that are in the money are obviously more expensive but they also have the highest delta it is more likely that those prices are going to be the final price or are going to be in the money when expiry is reached so the problem that many traders run into is that they look at the very expensive in the money options and they they shy away from them they'll go and they'll look at the delta on the options chain and they'll end up choosing or they won't look at the delta what they'll do is they look at the actual price and then they'll be like do I want to get something that's 900 you know or so dollars no that's too expensive I want something that's like $300 you know so I'll go for the $300 but you're actually picking an option an option that has a much smaller probability of ending up in the money which means that it's going to go to zero a lot quicker so you know do you really want to take that trade off do you really want to go for the cheaper contracts just because they are cheaper but you have a greater probability of losing everything well in using spreads and in the case of vertical spread you can go ahead and get a smaller debit or smaller price contract something that's still like $300 or you can get even $200 or $100 you know with the spread but you're not getting something that's so out of the money you know so you're not getting something that's improbable to reach you are getting those 190 you know 185 strikes which are a lot more probable to end up in the money than you would if you go ahead and get something like 225 or something like that right so that is the beauty of the spread and in this case in this particular case the vertical spread don't go for the cheaper contracts just because they're cheaper because the cheaper they are on the options chain as you go higher in price in strike price speaking of the the calls the cheaper they are the less probable they are to end up in the money which means the less probable you are making money with one of those contracts so it doesn't really make sense it makes more sense to get something that's deeper in the money but that you can hedge and cover with a sold call okay or put because you can do this with puts as well and that's going to bring your debit down it's going to bring your risk down but you're still buying a high quality contract which is that 190 call all right so i hope that this was useful if you have any questions on spreads then go ahead and and get them out of the way because in the next video we're going to be looking at other kinds of spreads which are not necessarily directional which are more neutral and that is or you can skew them a little bit towards the direction but and that is basically well where where delta and theta and vega really come into play so i hope to see you guys in the next video and don't forget to subscribe to our channel and go ahead and look for us on twitter as well as on xcord of course our community and i will see you guys in the next one have a great one