Trading Debit Spreads

Debit spreads are multi-leg option strategies that are executed simultaneously.  They are called debit spreads because they cost money to trade (debit to you).

Debit spreads are, potentially, less risky than long-call or long-put option trades.  But as with most option trades, it is possible to create some high-risk variations of the strategy.  In many cases, the position taken from one leg hedges the position taken on the other leg. 

The most common debit spreads are:

• Bull call spread
• Bear put spread
• Calendar spread (AKA: time spread)
• Butterfly spread

 Trade Note from Peter

One of the most important reasons to include debit spreads in your options trading arsenal is to mitigate risk.  Most traders who buy only long calls and long puts will eventually blow themselves up.  That’s because they tend to swing for the fences all too often.  Perpetual risk takers have no inherent advantage in option trading.  They may have their day in the sun.  But eventually they will lose everything.

Spreads can increase the likelihood that come expiration day, if your preferred sentiment is not reflected in the movement of the underlying stock, well, at least your loss may not be total.  The other side of that coin is that you will not reap the unlimited upside reward if your underlying stock moves dramatically in your predicted direction.  That’s a good tradeoff to accept once in a while.

Most brokers charge separate commissions for each option leg.