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If I believe a stock will go up, say from a price of $100, and I wish to execute an options strategy that would make me money if the stock were to rise, why would I want to setup a vertical spread when I could instead purchase a single naked call?

It seems to me that my transaction costs would be 2x with the spread, and while I see that time decay ( Theta ) is mitigated with a vertical spread, wouldn't the unbridled upside to unlimited theoretical profit of the naked call be better in the long run if this strategy is executed multiple times? Specifically, let's say I have a 50% chance that the stock will go up each time I execute. In that case, why not exercise the naked call each time because there's only one transaction fee?

Am I missing factors that would cause vertical spreads to be much more profitable? And if so, what would drive investors to choose one over the other specifically?

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    Out the money vertical spreads can gain a lot way before being close to the money. I would have to model a trade to give you a definite answer on how this can be better than buying calls. But check out deep out the money vertical spreads. – CQM May 1 '16 at 15:51
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    You can actually buy/sell spreads as a single instrument: cboe.com/cob/cob.aspx so the fees might not be as a big a deal as you think. – barrycarter May 1 '16 at 20:16
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    fees are tiny compared to capital risk, so even 2x something tiny is still tiny. The real benefit of a call vertical is reducing the cost of the long call. Sure, it limits upside, but the trade should be about maximizing reward/risk. – rocketman Nov 21 '17 at 19:57
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Figured it out. Vertical spreads significantly reduce the amount of "buying power" on the account needed vs. buying / selling pure calls / puts. So even though the transaction fees may more double in some instances, it may be worth it in order to operate with pricier underlying instruments.

Spreads are also considered "defined risk" trades where both the profit and loss are capped per how the spreads are setup. This is compared to single calls / puts where either the upside or the downside can be unlimited. So for times when the expected move is not as pronounced, a spread may be a better fit depending on environment and other factors.

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Question: are you saying that buying a call is better than buying a vertical spread regardless of fees, or only because of fees?

If the former, you are saying that buying a call and selling a vertical spread will always be profitable, which effectively means you're going short an out-of-the-money call.

While that's a good strategy, it doesn't guarantee profit, and will lose money exactly when the vertical spread is a better strategy than buying the call outright.

The most direct answer to your question in comments: if the stock goes down, you lose less money with the vertical spread than you do with a simple call.

In return for this lower risk, you give up gains if the stock goes above the higher calls strike price.

  • Mainly I suppose I'm asking: why use one over the other? Especially since @barrycarter pointed out that they can be treated as single instruments. – sean2078 May 2 '16 at 17:16
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Late to the party, but it's just improving your cost basis in a defined risk trade even further. If you want to put up less risk capital but want to test the waters, this can be one way to do it.

Another could be buying cheap OTM butterflies or financing a further otm option with the basis reduction from the debit spread if you want to gamble a bit further and venture into 15-20 delta positions.

Usually, I am doing debit spreads with a buying atm and selling a couple strikes further otm or at least at the most liquid strikes, but if it's a high flier, it can be disappointing, but a good trade. If you're more of a contrarian in where you buy your calls/puts, it's absolutely a good way to lessen your risk on a calculated bet.

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