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LSDefine
Simple English definitions for legal terms
option spread
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A quick definition of option spread:
An option spread is a term used in finance to describe the difference between the price of an option and the market price of the underlying stock when the option is exercised. It can also refer to the difference between the interest rate that a financial institution must pay to attract deposits and the rate at which money can be loaned, or the difference between the highest price a buyer will pay for a security and the lowest price at which a seller will sell a security. In securities, an option spread can also refer to the simultaneous buying and selling of one or more options or futures contracts on the same security in order to profit from the price difference. In investment banking, the spread is the difference between the price the underwriter pays the issuer of the security and the price paid by the public in the initial offering, which compensates the underwriter for its services.
A more thorough explanation:
An option spread is a term used in securities trading to describe the difference between the option price and the market price of the underlying stock when the option is exercised. This spread can be used to determine the potential profit or loss of an options trade.
- Suppose an investor buys a call option on a stock with a strike price of $50. If the stock price rises to $60, the investor can exercise the option and buy the stock at the strike price of $50, then sell it on the market for $60, making a profit of $10 per share. In this case, the option spread is $10.
- Another example is a put option on a stock with a strike price of $100. If the stock price falls to $80, the investor can exercise the option and sell the stock at the strike price of $100, then buy it back on the market for $80, making a profit of $20 per share. In this case, the option spread is $20.
These examples illustrate how the option spread can be used to calculate potential profits or losses in options trading. By understanding the option spread, investors can make informed decisions about whether to buy or sell options based on their expectations for the underlying stock's price movement.