Analysts often recommend a 1x2 call spread (buy one ATM or slightly OTM call option, sell two deep OTM call options) as a bullish trade or a 1x2 put spread for a bearish trade. Why? It does not make sense to me. An obvious risk with a 1x2 call spread is that you are correctly bullish on the stock but lose a lot of money if the stock rises past the strike of the deep OTM call. Unless one has a valid reason to believe that the deep OTM call options are mispriced relative to the ATM call, the simple trade of buying the ATM call seems more logical. I suspect that analysts recommend 1x2 spreads because strategies with low upfront costs are superficially appealing. That's not a rational way to trade options.

these structures are not usually proposed for the purpose of trading options but as speculative tools. I agree that there are risks with the trade - but I think the main idea is to choose strikes such that the options expire below (or above if they puts) the strikes you are short. clearly this is an art and not a science and the further out the short strike is the less youare going to get for them. Also, a couple of other points to bear in mind. if you are long the 1x2 spread and the stock rallies you still have a geenrous break-even level. Secondly, vols come off as the stock rallies and you can then use some of your profits to buy back one or both of your short calls.

There is an active market in 1x2's, i.e. you can call a dealer and get a two-way quote on a 1x2 and then buy/sell it as a unit. So trading them is convenient.If you think one call is overvalued vs. another it makes sense to buy one and short the other. But because the farther OTM one is worth less, it makes even more sense to trade several of the "little" ones versus one of the "big" ones. That is why 1x2's or in general 1xN's are popular. It is a rough approximation to the academics' idea of an arbitrage trade where you sell and buy items of equal value. BTW I once asked for a quote on a "one by 3.14159" and they laughed at me, so now I stick to 1x2, 1x3, 2x3 etc.; the dealers will gladly quote these.

A 1 x Pi, now there is a new strategy

I love 1x2s!

Thanks to you and the other people who replied. I would be more comfortable buying a call butterfly than a 1x2 spread to express a bullish view, since the extra OTM call I buy protects me from extreme up moves. Are there active markets in butterflies?

Yes, for ease of speaking they are often referred to simply as 'flies.

a 1x2 or 1xN is most appropriately used to trade on or against skew.

Quoterleshner, Junior Member, Posts: 1, Joined: Sep 2009. a 1x2 or 1xN is most appropriately used to trade on or against skew. Agreed. A brilliant first post.

I find 1x2 Option spread difficult to price and manage.In particular traders tend to like buying the 1x ATMF option and sell 2x ATMS option for small premium (in rates and fx, in equity I would assume they like the 1x2 call spread).The delta hedger that is short the 1x ATMF vs 2x ATMS possibly sees his delta position close to zero, but as the forward rate (or fx) rolls (tipically slowly) down toward the spot level, it might find himself forced to pay the max payout = ATMF - ATMS, having made close to nothing with his delta position and having received poor premium upfront.Not surprisingly ATMS usually are worth less in terms of vol (vol is lower).If delta hedger is short 1x2 put spread with fwd > spot, I expect this (need to check), in a scenario where prices on screens don't move:- delta decreases as time elapses (shorter day by day as the ATMF put delta falls more quickly)- delta increases as forward rolls down to spot- short gamma increases as time elapses- trader sells A nightmare !