A Debit Spread means two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold – both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.
Although there is an initial loss on the transaction, the investor is betting that there will be a significant change in the price of the underlying security, making the purchased option more valuable in the future. It is a spread option position in which the price of the option bought is greater than the price of the option sold.
A debit spread is an option spread strategy in which the premiums paid for the long leg(s) of the spread is more than the premiums received from the short leg(s), resulting in funds being debited from the option trader’s account when the position is entered.
The net debit is also the maximum possible loss when implementing the debit spread option strategy.
Vertical Debit Spreads
Bull Debit Spread
The bull call spread is the option strategy to employ when the option trader is bullish on the underlying security and wish to establish a vertical spread on a net debit.
Bear Debit Spread
If instead, the option trader is bearish on the underlying security, a vertical spread can also be established on a net debit by implementing the bear put spread option strategy.
Non-directional Debit Spread Combinations
Spreads can be combined to created multi-legged, debit spread combinations that are used by the option trader who does not know or does not care which way the price of the underlying security is headed but instead, is more interested in betting on the volatility (or lack thereof) of the underlying asset.
Bullish on Volatility
If the option trader expects the price of the underlying security to swing wildly in the near future, he can choose to implement one of the following spread combination strategies on a net debit.
Bearish on Volatility
If instead, the option trader expects the price of the underlying security to remain steady in the near term, he can choose to implement one of the following debit spread combination strategies.