Debit Spread

What Is a Debit Spread?

A debit spread, or a net debit spread, is a options strategy including the simultaneous buying and selling of options of a similar class with various strike prices requiring a net outflow of cash, or a "debit," for the investor. The outcome is a net debit to the trading account. Here, the sum of all options sold is lower than the sum of all options purchased, consequently the trader must put up money to start the trade. The higher the debit spread, the greater the initial cash outflow the trader causes on the transaction.

• A debit spread is an options strategy of buying and selling options of a similar class and different strike prices simultaneously.
• The aftereffect of the transaction is debit to the investor account.
• Many types of spreads include at least three options yet the concept is something very similar.

How a Debit Spread Works

Spread strategies in options trading typically include buying one option and selling one more of a similar class on a similar underlying security with an alternate strike price or an alternate expiration. Notwithstanding, many types of spreads include at least three options yet the concept is something very similar. On the off chance that the income collected from all options sold brings about a lower monetary value than the cost of all options purchased, the outcome is a net debit to the account, subsequently the name debit spread.

The opposite is true for credit spreads. Here, the value of all options sold is greater than the value of all options purchased so the outcome is a net credit to the account. As it were, the market pays you to put on the trade.

Illustration of a Debit Spread

For instance, assume that a trader buys a call option for $2.65. Simultaneously, the trader sells one more call option on a similar underlying security with a higher strike price of $2.50. This is called a bull call spread. The debit is $0.15, which brings about a net cost of $15 ($0.15 * 100) to start the spread trade.

In spite of the fact that there is an initial outlay on the transaction, the trader accepts that the underlying security will rise unassumingly in price, making the purchased option more significant later on. The most ideal situation happens when the security lapses at or over the strike of the option sold. This gives the trader the maximum amount of profit conceivable while restricting risk.

The contrary trade, called a bear put spread, likewise buys the more costly option (a put with a higher strike price) while selling the more affordable option (the put with a lower strike price). Once more, there is a net debit to the account to start the trade.

Bear call spreads and bull put spreads are both credit spreads.

Profit Calculations

The breakeven point for bullish (call) debit spreads utilizing just two options of a similar class and expiration is the lower strike (purchased) plus the net debit (total paid for the spread). For bearish (put) debit spreads, the breakeven point is calculated by taking the higher strike (purchased) and deducting the net debit (total for the spread).

For a bullish call spread with the underlying security trading at $65, here's a model:

Buy the $60 call and sell the $70 call (same expiration) for a net debit of $6.00. The breakeven point is $66.00, which is the lower strike (60) + the net debit (6) = 66.

Maximum profit happens with the underlying terminating at or over the higher strike price. Assuming the stock expired at $70, that would be $70 - $60 - $6 = $4.00, or $400 per contract.

Maximum loss is limited to the net debit paid.