Vertical construction as a bounded-risk procedure

A vertical is one bounded trade

A vertical-debit-spread is a same-expiry two-strike option structure that pays net premium to open and caps both gain and loss at expiry between those strikes.

It is an option-spread: a composite long-and-short option position used as one trade instead of a single call or put, so the payoff has defined floors and ceilings.

A vertical is labeled buy or long when opening it requires paying cash, and sell or short when opening it receives cash, even though each vertical already contains one long option and one short option. Debit-or-credit is that cash-flow label.

Build both legs together

A call vertical is constructed as long one call at a lower strike and short a cheaper same-series call at a higher strike. A put vertical is constructed as short one put at a lower strike and long a more expensive same-series put at a higher strike.

Buying a call vertical means buying the lower-strike call and selling the higher-strike call. Selling that vertical reverses both legs.

Buying a put vertical means selling the lower-strike put and buying the higher-strike put. Selling that vertical reverses both legs.

Clip the reckless-segment

Verticals exist to clip the sloping unbounded segment of a single call or put so that both maximum loss and maximum profit are reduced relative to the corresponding naked option.

That unbounded sloping part is the reckless-segment. The vertical clips it by trading away some profit or premium.

Relative to the matching naked option, buying a vertical spends less premium and therefore cuts maximum loss while also cutting profit potential. Selling a vertical collects less premium and therefore cuts maximum loss while also cutting profit potential.

Lock bounds from strike-width

Fair value of either a call vertical or a put vertical cannot exceed the distance between its strikes. Strike-width is that absolute distance. It is the theoretical ceiling on a vertical's fair value and on its maximum expiry gain.

For a call vertical that barrier is described as theoretically unattained, while a put vertical can reach it when the underlying is sufficiently low.

The risk-reward-ratio is the ratio of maximum possible profit to maximum possible loss implied by strike-width and the net debit or credit paid or received.

The four expiry constructions

At expiry the four named constructions are a bull debit vertical with calls, a bear debit vertical with puts, a bear credit vertical with calls, and a bull credit vertical with puts. Each has a payoff bounded by the two strikes.