Horizontal spread is a financial term used to describe a specific type of investment strategy involving options. This strategy involves the purchase of an option and the sale of an option at the same time. The two options have the same strike price and are the same type of option, but each option has its own maturity date. For example, an investor might buy an option with a maturity date of October 25 and sell the same type of option with the same strike price with a maturity date of March 18. The purpose of a horizontal spread, also known as a calendar spread, is to maximize the return on the option that is selling as it reaches its maturity date.
An option is an agreement between the buyer and seller. The agreement allows the buyer of the option contract to exercise the right to buy a security or financial instrument. The option contract states the terms and conditions of this right such as the price, which is called the strike price, the time period when the option can be exercised, or the specific date when the option buyer has the right to exercise the option, which is called the exercise date.
The horizontal spread investment strategy is the direct opposite of the vertical spread strategy. A vertical spread strategy occurs when the same type and number of options are being bought and being sold at the same time. The difference is that the options have different strike prices, instead of the same strike price that a horizontal spread strategy shares.
When referring to option types, there are two primary types or classes of options: American and European. When implementing a horizontal spread, the options that are being bought and sold must both be American or both be European. The difference between the two types of options relate to when the exercise option is available. The exercise option of American options is at any point from its purchase date to its maturity date, while European options are only eligible for exercise upon maturity or on the exercise date.
Two other types of options include call options and put options. A buyer would purchase a call option if the stock price is expected to go up, but a put option if the stock price is expected to go down.