Debit spread option strategies are formed by buying a Long option that is closer to the price (more In The Money) and selling a Short option that is further away (more Out Of The Money). Since more capital is spent on the longer option than is obtained from the credit received on the Short side, the position is a net debit (i.e. it costs money to open).
Debit Spreads can be formed from either calls or puts. A call debit spread is sometimes called a Bull Call Spread and a put debit spread referred to as a Bear Put Spread.
Debit Spreads can provide a lower risk alternative to buying a single Long Call or Put Option contract since any loss on the Long side is offset by the credit received from the Short position. The maximum gain from a debit spread is limited to the difference between the Long and Short strikes prices at Expiration, as such, the profit as well as the risk is restricted (as is the case with most spread-based option strategies)
The debit spread is a Directional Options Strategy because it requires the price of the Underlying to move above (in the case of calls) or below (in the case of puts) the Strike Price of the Long option. Debit spread strategies may also be combined with other option strategies, for example a Credit Spread to create a butterfly. These more advanced permutations can be part of a non-directional strategy.
See the profit & loss diagram of the Debit Spread strategy at OptionCreator.com
Example
XYZ is trading at $500
Long 1 x At The Money (ATM) $500 Strike Call for 16.17 = ($1617) debit
Short 1 x Out Of The Money (OTM) $520 Strike Call for 8.39 = $839 credit
Net debit to enter spread = ($778)
XYZ remains at $500
Long 1 x $500 Call expires worthless = (-$1617) loss.
Short 1 x $520 Call expires worthless = $839 profit.
Loss = (-$778)
XYZ rises to $520
Long 1 x $500 Call is worth $2000 minus $1617 debit = $383 profit .
Short 1 x $520 Call expires worthless = $839 profit.
Profit = $1222
XYZ falls to $480
Long 1 x $500 Call expires worthless = (-$1617) loss.
Short 1 x $520 Call expires worthless = $839 profit.
Loss = (-$778)
Contributed by: Ralph Windsor
Debit Spreads can be formed from either calls or puts. A call debit spread is sometimes called a Bull Call Spread and a put debit spread referred to as a Bear Put Spread.
Debit Spreads can provide a lower risk alternative to buying a single Long Call or Put Option contract since any loss on the Long side is offset by the credit received from the Short position. The maximum gain from a debit spread is limited to the difference between the Long and Short strikes prices at Expiration, as such, the profit as well as the risk is restricted (as is the case with most spread-based option strategies)
The debit spread is a Directional Options Strategy because it requires the price of the Underlying to move above (in the case of calls) or below (in the case of puts) the Strike Price of the Long option. Debit spread strategies may also be combined with other option strategies, for example a Credit Spread to create a butterfly. These more advanced permutations can be part of a non-directional strategy.
Debit Spread
See the profit & loss diagram of the Debit Spread strategy at OptionCreator.com
Example
XYZ is trading at $500
Long 1 x At The Money (ATM) $500 Strike Call for 16.17 = ($1617) debit
Short 1 x Out Of The Money (OTM) $520 Strike Call for 8.39 = $839 credit
Net debit to enter spread = ($778)
XYZ remains at $500
Long 1 x $500 Call expires worthless = (-$1617) loss.
Short 1 x $520 Call expires worthless = $839 profit.
Loss = (-$778)
XYZ rises to $520
Long 1 x $500 Call is worth $2000 minus $1617 debit = $383 profit .
Short 1 x $520 Call expires worthless = $839 profit.
Profit = $1222
XYZ falls to $480
Long 1 x $500 Call expires worthless = (-$1617) loss.
Short 1 x $520 Call expires worthless = $839 profit.
Loss = (-$778)
Related Directory Entries
Featured Video View All
Trading Debit Spreads
Joseph Cusick of Money Block describes how to trade debit spread option strategies.
External Links
4 Keys To Placing Your First Debit Spreadhttps://www.dough.com/blog/4-keys-to-understanding-debit-spreads
Dough.com article with some basic information about debit spread trades.
View Tasty Trade in Options Market Glossary Directory
When to Trade Credit or Debit Spreadshttp://www.moneyshow.com/articles.asp?aid=OptionsIdea-24436
Josip Causic describes the differences between debit and credit spreads as well as when to use each strategy.
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