What is a 'Debit Spread'

A debit spread, or a net debit spread, is an option strategy involving the simultaneous buying and selling of options with different prices requiring a net outflow of cash. This result is a net debit to the trading account. Here, the sum of all options sold is lower than the sum of all options purchased, therefore the trader must put up money to begin the trade.

The higher the debit spread, the greater the initial cash outflow the trader incurs on the transaction.

BREAKING DOWN 'Debit Spread'

Spread strategies in options trading typically involve buying one option and selling another on the same underlying security with a different strike price or a difference expiration. However, many types of spreads involve three or more options but the concept is the same. If the income collected from all options sold results in a lower money value than the cost of all options purchased, the result is a net debit to the account and the name debit spread.

The converse is true for credit spreads. Here, the value of all options sold is greater than the value of all options purchased so the result is a net credit to the account. In a sense, the market pays you to put on the trade.

For example, assume that a trader buys a call option for $2.65. At the same time, the trader sells another call option on the same underlying security with a higher strike price for $2.50. This is called a bull call spread. The debit is $0.15, which results in a net cost of $15 ($0.15 * 100) to begin the spread trade.

Although there is an initial outlay on the transaction, the trader believes that the underlying security will rise modestly in price, making the purchased option more valuable in the future. And the best-case scenario is that the option sold will expire worthless, giving the trader the maximum amount of profit possible while limiting risk.

The opposite trade, called a bear put spread, also buys the more expensive option (a put with a higher strike price) while selling the less expensive option (the put with a lower strike price). Again, there is a net debit to the account to begin the trade.

Bear call spreads and bull put spreads are both credit spreads.

Profit Calculations

The breakeven point for all bullish debit spreads using only two options is the strike price of the out-of-the-money (OTM) option plus the debit, itself. For bearish debit spreads, the breakeven point is also the strike price of the out-of-the-money (OTM) option minus the debit.

For a bullish call spread with the underlying trading at $65, for example:

Buy the $60 call and sell the $70 call for net debit of $6.00. The breakeven point is $66.00.

Maximum profit occurs at the higher strike price. In this case, that would be $70 - $60 - $6 = $4.00, or $400 per contract.

Maximum loss is limited to the net debit paid.

  1. Buy A Spread

    Buying a spread is an options strategy involving buying and selling ...
  2. Bull Spread

    A bull spread is a bullish options strategy using either two ...
  3. Vertical Spread

    A vertical spread strategy uses purchases and sales of the same ...
  4. Bull Call Spread

    A bull call spread is used when a moderate rise in the underlying ...
  5. Bear Put Spread

    A bear put spread is a bearish options strategy used to profit ...
  6. Debit

    A debit is an accounting entry that results in either an increase ...
Related Articles
  1. Trading

    Which Vertical Option Spread Should You Use?

    Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading.
  2. Trading

    Vertical Bull and Bear Credit Spreads

    This trading strategy is an excellent limited-risk strategy that can be widely used.
  3. Trading

    What is a Bull Call Spread?

    A bull call spread is an option strategy that involves the purchase of a call option and the simultaneous sale of another option.
  4. Trading

    Pencil in Profits in Any Market With a Calendar Spread

    Calendar spreads are a great way to combine the advantages of spreads and directional option trades in the same position.
  5. Trading

    S&P 500 Options On Futures: Profiting From Time-Value Decay

    Writing bull put credit spreads are not only limited in risk, but can profit from a wider range of market directions.
  6. Trading

    Understanding Bull Spread Option Strategies

    Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.
  7. Trading

    Collecting Option Premium In The Grain Market

    Believe it or not, there are some great income-generating strategies that are lower in risk.
  8. Personal Finance

    Tips for Answering Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of the Series 7.
  1. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  2. How Do Speculators Profit From Options?

    Options are a risky game, but you can learn speculators' tricks to use them to your advantage. Read Answer >>
  3. How do I set a strike price for an option?

    Learn about the strike price of an option and how to set a strike price for call and put options depending on risk tolerance ... Read Answer >>
  4. What is the difference between in the money and out of the money?

    Learn how the difference between in the money and out of the money options is determined by the relationship between strike ... Read Answer >>
  5. Can an Option Have a Negative Strike Price?

    When it comes to exchange traded options, an option can't have a negative strike price. Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center