Trading Credit and Debit Spreads

This is an outline to help understand credit spreads and debit spreads in the options market.  These are very common strategies we use in Trade Desk.

Call Credit Spread – (C.C.S.)

• A bearish bias on the market
• Trade 1 – selling a call with a lower strike and money is received (hence the credit) in your account.
• Trade 2- simultaneously buying a call with a higher strike in the same expiration month. Capital is subtracted from your account for the purchase
• The capital result is positive cash flow to your account because you will receive more money for the lower strike call sale then received for the higher strike call purchase.
• The maximum profit on the trade is credit received for the 2 trades
• Maximum risk is the difference between the two strikes less the credit received at the time the trade was initiated.
• Example:
  • Sell 1 INTC March 38 call for $0.75 +$75.00
  • Buy 1 INTC March 40 call for $0.30 ($30.00)
  • Net credit is $45 to your account, maximum gain
  • Max risk is $40-$38 = $2.00 +$0.45 = $1.55

Call Debit Spread – (C.D.S.)

• A bullish bias on the market
• Trade 1 –buy a call with a lower strike for a cost to your account.
• Trade 2- simultaneously selling a call with a higher strike in the same expiration month. Capital is subtracted from your account for the purchase
• The capital result is negative cash flow to your account because you will spend more money for the lower strike call purchase then received for the higher strike call sale.
• The maximum profit on the trade is lower strike minus the higher strike less the premium paid for the trade at initiation.
• Maximum risk is the premium paid for the trade at initiation
• The trade is at breakeven once the underlying rallies above the premium paid for the trade
• Example:
  • Buy 1 INTC March 38 call for $0.75 ($75.00)
  • Sell 1 INTC March 40 call for $0.30 +$30.00
  • Net debit is $45 to your account, maximum risk
  • Maximum gain is $40-$38 = $2.00 – $0.45 = $1.55
  • Breakeven is $38.00 + $0.45 = $38.45
  • Gains are capped at the short strike of $40.00

Put Credit Spread – (P.C.S)

• A bullish bias on the market
• Trade 1 –Sell a put with a higher strike and money is received (hence the credit) in your account.
• Trade 2- Simultaneously buy a put with a lower strike in the same expiration month. Capital is subtracted from your account for the purchase
• The capital result is positive cash flow to your account because you will receive more money for the higher strike put sale then received for the lower strike put purchase.
• The maximum profit on the trade is credit received for the 2 trades
• Maximum risk is the difference between the two strikes less the credit received at the time the trade was initiated.
• Example:
  • Sell 1 INTC March 35 put for $1.25 +$125.00
  • Buy 1 INTC March 33 put for $0.70 ($70.00)
  • Net credit is $55 to your account, maximum gain
  • Max risk is $35-$33 = $2.00 + $0.55 = $1.45

Put Debit Spread – (P.D.S)

• A bearish bias on the market
• Trade 1 – buy a put with a higher strike for a cost to your account.
• Trade 2- simultaneously sell a put with a lower strike in the same expiration month. Capital is subtracted from your account for the purchase
• The capital result is negative cash flow to your account because you will spend more money for the higher strike put purchase then received for the lower strike put sale.
• The maximum profit on the trade is higher strike put minus the lower strike put less the premium paid for the trade at initiation.
• Maximum risk is the premium paid for the trade at initiation
• The trade is at breakeven once the underlying declines below the premium paid for the trade
• Example:
  • Buy 1 INTC March 35 put for $1.25 ($125.00)
  • Sell 1 INTC March 33 put for $0.70 +$70.00
  • Net debit is $0.55 or $55.00 to your account, maximum risk
  • Maximum gain is $35-$33 = $2.00 – $0.55 = $1.45
  • Breakeven is $35.00 – $0.55 = $34.45
  • Gains are capped at the short strike of $30.00