Debit Spreads are an options trading strategy where a trader buys one option and sells another of the same type (calls or puts) with the same expiration date but different strike prices. The result is a net debit, meaning the trader pays money upfront to enter the trade.
How they Work
- Buy a higher-premium option (closer to the current price).
- Sell a lower-premium option (further from the current price).
- The difference in premiums results in a net debit to the trader’s account.
Importance of Debit Spreads
- Defined Risk – The maximum loss is the initial debit paid, making it a safer strategy than buying single options.
- Lower Cost – Compared to buying a single option outright, debit spreads reduce upfront costs.
- Profit Potential – Traders can still benefit from price movements while capping their downside.
- Flexibility – Works in bullish (call debit spread) and bearish (put debit spread) market conditions.
- Time Decay Advantage – Unlike single options, debit spreads mitigate the impact of time decay.
Examples
Call Debit Spread (Bullish Strategy)
- Also known as a Bull Call Spread
- Buy a call option at $100 for $3.00 premium.
- Sell a call option at $105 for $1.00 premium.
- Net Debit: $2.00 per contract (since you pay more for buying than you receive for selling).
Outcome Scenarios
- If the stock rises above $105, the spread reaches its maximum profit of $3.00 per contract.
- If the stock stays below $100, both options expire worthless, and the trader loses the $2.00 debit paid.
- If the stock closes between $100 and $105, partial profits or losses occur.
This strategy allows traders to limit risk while benefiting from moderate bullish movements.
Put Debit Spread (Bearish Strategy)
- Also known as a Bear Put Spread
- Buy a put option at $100 for $3.00 premium.
- Sell a put option at $95 for $1.00 premium.
- Net Debit: $2.00 per contract (since you pay more for buying than you receive for selling).
Outcome Scenarios
- If the stock falls below $95, the spread reaches its maximum profit of $3.00 per contract.
- If the stock stays above $100, both options expire worthless, and the trader loses the $2.00 debit paid.
- If the stock closes between $95 and $100, partial profits or losses occur.
This strategy allows traders to limit risk while benefiting from moderate bearish movements.
