How a debit spread works
A debit spread buys one option and sells a cheaper one further out of the money, on the same expiry. The option you sell pays for part of the one you buy, so the trade costs less than a single option. In exchange, the gain is capped at the short strike.
- Bull call spread: buy a call, sell a higher-strike call. Profits if the shares rise.
- Bear put spread: buy a put, sell a lower-strike put. Profits if the shares fall.
max loss = debit × 100
max profit = (width − debit) × 100
breakeven (call) = long strike + debit · breakeven (put) = long strike − debit
A worked example
With the figures loaded above, the shares are at $100. You buy the 100 call and sell the 105 call for a net debit of $1.85.
- Maximum loss is the $185 paid, if the shares finish at or below $100.
- Maximum profit is ($5 − $1.85) × 100 = $315, if they finish at or above $105.
- Breakeven is $100 + $1.85 = $101.85: the shares need to rise 1.85% by expiry.
- Return on risk is $315 ÷ $185 = 170%, and the break-even win rate is $185 ÷ $500 = 37%.
Compare the credit spread: there you collect a little and risk a lot, and need to be right most of the time. Here you risk a little to make more, and can be wrong most of the time. Neither is better in itself; the option prices set the odds in both cases.
Choosing the strikes
- Width sets the payoff. A wider spread costs more and can make more. A narrow one is cheap but caps quickly.
- Where the strikes sit sets the odds. Buying an in-the-money call and selling an at-the-money one costs more but needs less movement. Two out-of-the-money strikes are cheap and need a large move.
- Time works against you. A debit spread loses value as expiry nears if the shares do not move. Choose an expiry that gives the move time to happen.
- Check the expected move. The expected move calculator shows the range the options market prices in. A breakeven outside it is a long shot.
Size the position from the debit, which is the whole risk: the contracts guide shows the arithmetic.