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8.4 Spreads and Combinations

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Series 7 General Securities Representative

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1 Introduction

About the Series 7 How to Use This Guide

2 Chapter 1: Equity Securities

1.1 Common Stock Basics 1.2 Dividends and Stock Splits 1.3 Preferred Stock 1.4 Rights and Warrants 1.5 ADRs and Foreign Securities

3 Chapter 2: Debt Securities

2.1 Bond Fundamentals 2.2 Bond Yields and Pricing 2.3 Corporate Bonds 2.4 Bond Features and Risks

4 Chapter 3: U.S. Government & Agency Securities

3.1 Treasury Securities 3.2 Agency Securities 3.3 Mortgage-Backed Securities 3.4 Money Market Instruments

5 Chapter 4: Municipal Securities

4.1 Municipal Bond Basics 4.2 General Obligation Bonds 4.3 Revenue Bonds 4.4 Municipal Bond Analysis 4.5 Municipal Securities Rules

6 Chapter 5: Investment Companies

5.1 Investment Company Basics 5.2 Mutual Funds (Open-End Funds) 5.3 Mutual Fund Pricing and Fees 5.4 Closed-End Funds and ETFs 5.5 Investment Company Taxation

7 Chapter 6: Variable Products & Annuities

6.1 Annuity Basics 6.2 Variable Annuities 6.3 Annuity Taxation 6.4 Variable Life Insurance

8 Chapter 7: Alternative Investments & DPPs

7.1 Direct Participation Program Basics 7.2 Types of DPPs 7.3 DPP Suitability and Risks 7.4 Real Estate Investment Trusts (REITs) 7.5 Hedge Funds and Other Alternatives

9 Chapter 8: Options

8.1 Options Basics 8.2 Long and Short Option Positions 8.3 Hedging Strategies 8.4 Spreads and Combinations 8.5 Index and Non-Equity Options 8.6 Options Account Requirements

10 Chapter 9: Customer Accounts

9.1 Account Types 9.2 Cash Accounts 9.3 Margin Accounts 9.4 Margin Calculations 9.5 Fiduciary and Institutional Accounts

11 Chapter 10: Retirement & Education Plans

10.1 ERISA and Qualified Plans 10.2 Defined Benefit vs. Defined Contribution 10.3 Individual Retirement Accounts 10.4 Education Savings Plans 10.5 Plan Distributions and Taxation

12 Chapter 11: Securities Markets & Trading

11.1 The Primary Market 11.2 The Secondary Market 11.3 Order Types and Execution 11.4 Trade Settlement and Reporting 11.5 Market Participants

13 Chapter 12: Rules, Regulations & Ethics

12.1 Regulatory Framework 12.2 Suitability Requirements 12.3 Communications with the Public 12.4 Prohibited Activities 12.5 Customer Protection Rules 12.6 Ethics and Professional Conduct

8.4 Spreads and Combinations

Key Takeaways Explain This Topic AI

Spreads use two options of the same type (both calls or both puts) to define risk.

Debit spreads pay net premium and want the underlying to move toward the strikes.

Credit spreads receive net premium and want the underlying to stay put.

Straddles use one strike; strangles use two OTM strikes — both are volatility plays.

Long straddle/strangle profit from big moves; short versions profit from stability.

Last updated: June 2026

What a Spread Is

A spread is the simultaneous purchase and sale of two options of the same type (both calls or both puts) on the same underlying, differing in strike, expiration, or both. Spreads cap both profit and loss, giving defined risk , which is why conservative directional traders favor them over naked positions.

Debit vs. Credit

  • Type Net premium Wants the stock to... Max gain Max loss
  • Debit spread Pay (buy the costlier option) Move (toward the strikes) Strike difference − net debit Net debit

Credit spread Receive (sell the costlier option) Stay (away from the strikes) Net credit Strike difference − net credit

Memory tip: In a debit spread you want the spread to widen ; in a credit spread you want it to narrow to zero so you keep the credit.

Bull Call Spread (Debit, Moderately Bullish)

Buy the lower-strike call, sell the higher-strike call.

Buy 1 XYZ 50 call @ $5, sell 1 XYZ 55 call @ $2 → net debit $3:

  • Item Formula Result
  • Max gain (Higher − lower strike) − net debit ($55 − $50) − $3 = $200
  • Max loss Net debit $3 x 100 = $300
  • Breakeven Lower strike + net debit $50 + $3 = $53
  • Bear Put Spread (Debit, Moderately Bearish)

Buy the higher-strike put, sell the lower-strike put.

Buy 1 XYZ 55 put @ $5, sell 1 XYZ 50 put @ $2 → net debit $3:

  • Item Formula Result
  • Max gain (Higher − lower strike) − net debit ($55 − $50) − $3 = $200
  • Max loss Net debit $3 x 100 = $300
  • Breakeven Higher strike − net debit $55 − $3 = $52
  • Credit Spreads

Bull put spread (moderately bullish): sell the higher-strike put, buy the lower-strike put. Max gain = net credit; max loss = strike difference − net credit.

Bear call spread (moderately bearish): sell the lower-strike call, buy the higher-strike call. Same max-gain/max-loss formulas.

Exam alert: Identify the spread by the option you buy at the more expensive strike . If you pay net premium it is a debit spread; if you receive net premium it is a credit spread. The dominant (net long or net short) leg sets the directional bias.

Straddles — Same Strike, Same Expiration

A straddle is a call and a put with the same strike and expiration . It is a pure volatility bet — direction does not matter, magnitude does.

Long Straddle (expect a big move)

Buy 1 XYZ 50 call @ $3 and buy 1 XYZ 50 put @ $2 → total premium $5:

  • Item Detail
  • Market view High volatility (big move either way)
  • Max gain Unlimited (upside) or strike − premium (downside)
  • Max loss Total premium = $500
  • Breakevens $50 + $5 = $55 and $50 − $5 = $45

The stock must move beyond $55 or below $45 to profit — it must overcome both premiums.

Short Straddle (expect stability)

Sell 1 XYZ 50 call @ $3 and sell 1 XYZ 50 put @ $2 → collect $5:

  • Item Detail
  • Market view Low volatility (stock pins near strike)
  • Max gain Total premium = $500
  • Max loss Unlimited (call side)
  • Breakevens $55 and $45
  • Strangles — Two OTM Strikes

A strangle uses different strikes , usually both out-of-the-money, lowering cost but widening the breakeven band.

Long strangle — buy 1 XYZ 55 call @ $2 and buy 1 XYZ 45 put @ $1 → total $3:

  • Item Detail
  • Market view High volatility
  • Max loss Total premium = $300
  • Breakevens $55 + $3 = $58 and $45 − $3 = $42
  • Cost Cheaper than a straddle because both legs are OTM
  • Spread Categories
  • Spread Strikes Expirations Purpose
  • Vertical Different Same Directional, defined risk
  • Horizontal (calendar) Same Different Time-decay play, neutral
  • Diagonal Different Different Combination of both
  • Strategy-to-View Quick Map
  • Outlook Strategy
  • Strongly bullish Long call
  • Moderately bullish Bull call (debit) or bull put (credit) spread
  • Big move expected (either way) Long straddle or long strangle
  • Stable/quiet market Short straddle or short strangle
  • Moderately bearish Bear put (debit) or bear call (credit) spread
  • Strongly bearish Long put

Common trap: A long straddle profits from volatility , not direction — the exam will offer "bullish" or "bearish" distractors. The strangle is always cheaper than the straddle but needs a larger move to break even.