from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up


Debit Spreads

All About Debit Spreads - Definition, An Example, and How to Use

A debit spread comes about when you purchase one option and simultaneously sell an option (for the same underlying security, of course), and you have to shell out some cash to buy the spread.  When you buy a debit spread, except in unusual circumstances (see below), you only have to come up with the difference between what the option cost that you bought and what you received from selling the other option to someone else.

Debit spreads are purchased to reduce risk.  The other side of the coin is that the maximum gain is limited.  For example, you might buy a one-month call option at the 70 strike for XYZ stock selling at $70 and pay $3.00.  If you just bought the option, your cost would be $300 plus commissions, and that is the maximum you could lose.  If the stock goes up to $80, you could sell the option for $10.00 and make a whopping gain of $700.  However, it doesn't happen that way very often. Stocks usually don't shoot up by $10 in a single month.

Another choice would be to buy a debit spread, sharing both the risk and potential reward with someone else.  You could probably sell a one-month 75 call on the above stock for $1.50.  If you did that, you would collect $150 from someone else and cut your total risk in half. (Your debit spread in this case would be called a vertical spread.)  If the stock goes up to $75 in one month (a much more likely event that having it go up to $80), you would make a gain of $350 less commissions on an investment of $150.  At a $75 ending price, the person who bought the 75 call would lose his entire investment while you made over 200% on yours.

If the stock did manage to go up to $80, your debit spread would still earn you $350, but that is the maximum you could ever gain.  Meanwhile, at $80, the person who bought the 75 call would also make $350 on his investment.  In the real world, however, your chances of a maximum gain are many times greater than the person who did not buy a debit spread, but only bought a call option instead (and paying the same amount, $150, for his investment as you did for your debit (vertical) spread).

Debit spreads do not have to be only vertical spreads.  A calendar spread, also called a time spread or a horizontal spread, is also a debit spread.  Diagonal spreads can also be debit spreads.  For example, you could buy a call option with many months of remaining life and sell a higher-strike call with only a single month of remaining life.  That would be a debit (diagonal) spread.  As with most debit spreads, you would only have to come up with the difference between what you paid for the long option and what you received by selling the short option.

There are certain spreads where you have to come up with more cash than the debit spread cost.  For example, if you bought a diagonal call spread, buying a 70 strike call with 6 months of remaining life and selling a 65 call with only a single month of remaining life, you might be able to buy the spread at a debit.  However, theoretically, you could lose $500 on the spread (if the stock shot higher, above $70, and never returned. 

The broker would charge you a $500 maintenance requirement on this spread even though it is highly unlikely that you would ever lose that much.  At the end of the first month when the 65 strike call expired, you would have to buy it back for its intrinsic value.  Of course, it is unlikely that you would lose much if the stock did shoot up above $70.  When you bought back the expiring 65 call, your 70 call with several months of remaining life could probably be sold for a greater amount than it cost you to buy back the 65 call.

In my discussion of spreads, I am assuming that you will never allow an in-the-money call or put to be exercised (i.e., either buying someone's stock at the call price or forcing someone to buy shares of your stock at the put price).  The great majority of the time, option traders choose to close out in-the-money options at or near expiration rather than buying or selling shares of stock.  Shares of stock are for stock investors.  Option investors are different - they prefer to tie up less money (while also trying to make a much higher return on investment than owning stock).  Owning stock usually involves waiting patiently for years for it to go up.  Option traders are not so patient.  They like to see action today and tomorrow, not a decade from now.

For a good explanation of debit spreads in action, get a free report entitled "How to Make 70% a Year With Calendar Spreads" when you sign up for our free newsletter.

Terry's Tips Stock Options Trading Blog

April 17, 2017

40% Possible in 2 Weeks With an Iron Condor?

Today’s idea involves an esoteric Exchange Traded Product (ETP) called SVXY. It is one of our favorite underlyings at Terry's Tips. Chances are, you don’t know very much about it, and I can’t help you much in this short note. But I will share a trade I made on this ETP this morning, and my thinking behind this trade.


40% Possible in 2 Weeks With an Iron Condor?

The best way to explain how SVXY works might be to explain that it is the inverse of VXX, the ETP that some people buy when they fear that the market is about to crash. Many articles have been published extolling the virtues of VXX as the ideal protection against a setback in the market. When the market falls, volatility (VIX) most always rises, and when VIX rises, VXX almost always does as well. It is not uncommon for VXX to double in value in a very short time when the market corrects.

The only problem with VXX is that in the long run, it is just about the worst equity that you could . . .

April 7, 2017

Trading Options Can be a Lifetime Learning Experience

I have been trading options just about every day the market is open for about 40 years, including some time on the floor of the CBOE. I have made large sums of money at times, and (sadly) have also lost money along the way. But the amazing thing about my experience is that I continue to learn things even after all these years.

Today I would like to talk about trading options with an analogy.


Trading Options Can be a Lifetime Learning Experience . . .

April 4, 2017

44% in 46 Days From a Play on ULTA?

I would like to share a trade that we made in one of our Terry's Tips portfolios today. By the way, we have 9 portfolios that we carry out for paying subscribers where they can see every trade (including commissions) as we make them. All of these portfolios have made positive gains so far in 2017, and the composite average has picked up 28.8% at the end of the first quarter. Not bad compared to conventional investment results.

Enjoy today’s offering.


44% in 46 Days From a Play on ULTA?

There is a lot to like about Ulta Salon, Cosmetics & Fragrance's (ULTA). It has been a darling of Wall Street this year, rising about 50%. It appears on IBD’s Top 50 list of momentum stocks. The Motley Fool guys have written over 300 articles on the company and include it in their top three beauty stocks. The company has a plan to add on 500 new stores, and they have exceeded earnings estimates every quarter for the past year.

The chart for the last year shows . . .

Making 36%

Making 36% – A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

Order Now

Sign Up Your 2 Free Reports & Our Newsletter Now!

Sign up for Dr. Terry F Allen’s free newsletter and get immediate access to his most current report on his stock option trading strategies.

TD Ameritrade

Member Login  |  Programs and Pricing  |  Testimonials  |  About Us  |  Legal Notices  |  Accessibility Statement  |  Privacy Policy  |  Site Map

TD Ameritrade, Inc. and Terry's Tips are separate, unaffiliated companies and are not responsible for each other’s services and products.

©Copyright 2001–2017 Terry's Tips, Inc. dba Terry's Tips

Close Window

Sign up for the Terry’s Tips Free Newsletter and Receive 2 Options Strategy Reports:


Login to Your Existing Account Now

No Thanks

Newsletter Signup

Member Login

Enter your primary email below, and we'll send you a new password