Analyze Vertical Spreads with the Risk Profile Tool

August 28, 2023 Advanced
Learn how to set up and analyze an options spread using the Risk Profile tool on the thinkorswim® platform for more complex trades like vertical spreads.

The following content is intended for options traders with substantial options knowledge. If you're not familiar with options, please review our options content for beginners available to Schwab clients.

One of the tools an option trader can use to analyze a potential trade is the Risk Profile tool on the thinkorswim® platform. 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 vertical1 spread—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. Select Vertical.

This chart illustrates how to analyze a spread by right-clicking any strike and choosing a strategy.

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 = $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.

The chart shows a risk profile of one 105-100 short put spread sold for $0.61. The purple line is the present-day profile. The blue line shows the profile on the options expiration date.

Source: thinkorswim platform

For illustrative purposes only. Past performance does not guarantee future results.

Understanding the scenarios

The blue line in the chart above represents the profit and loss (P&L) of the trade 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 (1), the trade would be down about $47. But then if the underlying remained at that level until expiration (2), the trade could end up making $61. Both legs would expire worthless, and you'd 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 money2, 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.

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.

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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options" before considering any options transaction. Spread trading must be done in a margin account. Supporting documentation for any claims or statistical information is available upon request.

Commissions, taxes and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.