Stock Market Debit Spreads Investing Explained An options strategy that carries an upfront cost, debit spread seeks to attain maximum profit for the trader. How is this achieved? By ensuring that premiums paid for the spread’s long legs exceed the premiums received from its short legs. I will be explaining how debit spreads for stock market investors are a perfect alternative for investing, without owning shares.
Too complicated for you to understand? No problem, I’ll break down debit spreads by using more straightforward language that anyone can understand.
Breaking Down Debit Spreads for Stock Market Investors
In options trading, spread strategies usually work like this—one option is bought and another one is sold on the same underlying security using a different expiration or a different strike price.
Although some spreads can involve three or more options, the concept remains the same.
If the revenue from all sold options is lower than the cost at which the options were bought, then this will result in a net debit to the account, and this is where the name debit spread comes from.
Used mostly by people who are new to options strategies, debit spread involves purchasing an option with a higher premium and selling another option with a lower premium at the same time.
Here, the premium paid for the spread’s long option is more than the premium received from the written option.
The result of a debit spread is the premium paid or debited from the account of the trader or investor on the opening of the position. The primary purpose of a debit spread is to balance the cost associated with the ownership of long options positions.
Here is an example to understand the debit spread. Suppose, a trader buys a put option with a strike price of $24 for $9 and sells another put option with a strike price of $12 for $4.
This means that the trader paid $5, or $500 for the trade. In case of out of the money (OTM) trade, the trader’s maximum loss is reduced to $500, as opposed to $900 if he only purchased the put option.
Now, there are two types of debit spreads: bull call debit spread and bear put debit spread.
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