The vertical debit spread

In my last option strategy post, I spoke about the vertical credit spread. The vertical debit spread is like the aforementioned except it is done in a debit as opposed to a credit.

Let's review a few concepts. A vertical spread is where a person buys and sells the same number of options in the same month. The credit spread is where the option sold is more than the option bought giving the person a credit. The vertical debit spread has an advantage when time value and implied volatility decline. A vertical credit spread profitability is neutral where the risk is direction one way. Think of a debit spread as buying an option and selling a option to offset the cost of the option that was bought.

A debit spread is a little harder to understand. To go profitable the spread has to widen or the difference in the price of the call bought and the call sold has to increase. When this position is closed if the the difference is larger the player will receive more money. The maximum loss in this position is the debit. The maximum profit in this position is the spread minus the debit.

Let's take a look at an example.

You buy a Aug 400 Goog put for $10.20 and sell a Aug 390 put for $6.70. If Goog is neutral or
rises by option expiration, a $10.20-$6.70=$3.50 would be created. If Goog drops below $390.00 before OE the profit would be the spread ($400 - $390=$10) less the premium paid or $6.50. This is called a bear put debit spread.Now the converse is true with a bull call debit spread. An example would be: You buy a August 410 call for $13.05 and sell a Aug 420 call for $8.65. Your debit is $4.40 and your maximum profit is $5.60. This spread is looking for Goog to rise near or above $410.

You see that all I did in the example was to turn around the buys and the sells in my post of vertical credit spreads. We will be following option contracts that will help show how these various strategies work. There are many other types of spreads that may be done in a debit position and understanding the various types of option plays will allow you to have some different ways to play options.

Good luck investors