What Is Strike Width?
Strike width is the difference between the strike prices of the options used in a spread trade. Strike width is most commonly associated with options strategies that include spreads, such as credit spreads or iron condors.
How Strike Width Works
Strike width matters in options trading strategies that rely on a spread, such as credit spreads or iron condors. The larger the strike width, the more risk that the option seller is taking on. For a buyer though, the potential for greater profits exists with a larger strike width compared to one with a smaller strike width. Increasing the strike width can improve an investor’s upside potential, though generally this means there is more of an upfront cost to the spread.
The price of an option depends on several factors, including the price of the underlying asset, the implied volatility of the option, the length of time until expiration, and interest rates. The strike price of the option represents the price at which a put or call option can be exercised at. Investors selling options want to ensure that the strike price they choose will maximize their probability for profit.
Strike Width Example
Let's say an investor wants to sell a call spread in MSFT, which is trading at $100. The trader decides to sell 1 MSFT March 100 strike call and buy 1 MSFT March 110 strike call. The strike width is 10, which is calculated as 110 - 100. For this trade, the investor will receive a credit since the call being sold is at the money and therefore has more value than the out of the money option being bought.
Now consider if the trader sold the 100 call and buys a 130 call. The strike width is 30. Assuming the same number of options are traded (as in scenario one), the credit received will increase substantially, since the bought call is even further out of the money and costs less than the 110 strike option. The risk on the trade has also increased substantially for the seller in the second scenario. The max risk in both scenarios is the width of the spread minus the credit received.
In the second scenario, the premium received is greater, so the potential profit is larger than the first, but the risk is larger if the stock keeps heading higher. The first scenario has a smaller premium received than the second, but the risk is lower if the trade doesn't work out.
When trading option spreads, traders need to find a balance between the credit received and the risk they are taking on.