Debit vs Credit Vertical Spread

Discussion in 'Options' started by xraptorx, Jan 26, 2010.

  1. xraptorx

    xraptorx

    I have a beginner question about Debit vs Credit vertical spreads. Are they basically equal?

    For example EWZ is at 67. Say I want to do a MARCH Bull Put Spread. i can do that by:

    DEBIT SPREAD:
    + Mar 65 PUT
    - Mar 64 PUT
    0.32 DR

    Thus I pay $32 to buy the contract.

    MAX Outcomes (ignoring if price is inbetween 2 strikes):
    * EWZ > 65: I collect 100 and profit is $68 (100 - 32)
    * EWZ < 64: I only lose what I paid for the contract ($32). Loss = $32

    CREDIT SPREAD:
    - Mar 65 PUT
    + Mar 64 PUT
    0.32 CR

    Thus, I get paid $32 to sell the contract.


    MAX Outcomes (ignoring if price is inbetween 2 strikes):
    * EWZ > 65: I keep the $32 I sold contract for. Profit is $32
    * EWZ < 64: I must pay 100 and keep $ received for sale of contract. Loss is thus: 100 - 32 = $68

    Both are Bullish on EWZ but it seems the Debit spread gives me a profit of 68 for a risk of 32.
    The Credit Spread gives me a profit of 32 for a risk of 68.
    Is this correct? Both also have the same % chance of loss.

    Is my understanding mixed up somewhere? There are a lot of advocates for credit spreads, but I wonder why when it seems that debit spreads are better :confused: :confused:
     
  2. MTE

    MTE

    The first trade where you buy the 65 put and sell the 64 put is a bearish trade where you want the stock to be below 64 to make the max profit, and if it is above 65 then you lose the premium paid.

    The second trade is a bullish one.

    Here's what I think you were trying to say. A debit call spread is equal to a credit put spread at the same pair of strike prices and vice versa.

    So in your example,

    buy 64 put
    sell 65 put

    is equal to

    buy 64 call
    sell 65 call

    Or

    sell 64 put
    buy 65 put

    is equal to

    sell 64 call
    buy 65 call
     
  3. Free software from CBOE that has a basic tutorial on spreads and the capability to construct and analyze positions containing up to 4 different options.
    http://www.cboe.com/LearnCenter/Software.aspx
     
  4. Long the 65/64 debit put spread is bearish not bullish. Re-do your numbers and conclusions.

    The 65/64 put spread is the same as the 65/64 call spread.
     
  5. Would you prefer to short-sell a position that creates a $32 credit or pay a $68 debit for a position that will be worth $100 later? :)
     
  6. rew

    rew

    As everyone else has pointed out, your second example is bullish -- you're betting that EWZ won't go below $65.

    In theory, if they are priced correctly, you should be able to lose money equally well by buying debit spreads or selling credit spreads. A credit spread that pays you $32 but can lose $100 will presumably expire worthless about 2/3rds of the time.

    If you are considerably more confident that a stock won't go down than you are that it will go up it may make more sense to sell a bull put spread than to buy a bull call spread. But unless you believe that options are persistently overpriced there is no inherent advantage to selling spreads over buying them.