Debit Spread Explained: Definition, Examples, and Comparison With Credit Spreads

What Is a Debit Spread?

A debit spread, or a net debit spread, is an options strategy where the investor simultaneously buys and sells options with different strike prices. Since the value of the options sold is lower than the value of the options purchased, the trader must put up money to begin the trade, resulting in a net debit to their trading account.

Traders can use debit spreads to limit their risk while profiting from modest changes in the asset's price. The higher the debit spread, the greater the initial cash outflow for the transaction.

Understanding the Mechanics of Debit Spreads

Spread strategies in options trading typically involve buying one option and selling another of the same class on the same underlying security with a different strike price or a different 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 monetary value than the cost of all options purchased, the result is a net debit to the account, hence the name debit spread.

For credit spreads, the value of options sold exceeds the value of options bought, resulting in a net credit to the account. In a sense, the market pays you to put on the trade.

Practical Example of Implementing a Debit Spread

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 of $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.

The trader expects the underlying security to increase in price, making the purchased option more valuable, despite the initial cost. The best-case scenario happens when the security expires at or above the strike of the option sold. This strategy maximizes potential profit 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.

How to Calculate Profit in Debit Spreads

The breakeven point for bullish (call) debit spreads using only two options of the same class and expiration is the lower strike (purchased) plus the net debit (total paid for the spread). For bearish (put) debit spreads, the breakeven point is calculated by taking the higher strike (purchased) and subtracting the net debit (total for the spread).

For a bullish call spread with the underlying security trading at $65, here's an example:

Buy the $60 call and sell the $70 call (same expiration) for a net debit of $6.00. The breakeven point is $66.00, which is the lower strike (60) + the net debit (6) = 66.

Maximum profit occurs with the underlying expiring at or above the higher strike price.  If the stock expires at $70, the profit would be $4.00 per share, totaling $400 per contract.

Maximum loss is limited to the net debit paid.