Table of Contents
Main topics covered today will be
Advantages of debit spread vs credit spread
Advantages of credit spread vs debit spread
Why prefer debit vs credit spread
To know credit vs debit spread-which is better
Who uses credit vs debit spreads
Summary of key points to remember in credit vs debit spread
Debit Spreads vs Credit Spread ? Which is best and when ?
When you are trying to get a answer for whether to go for Debit Spread vs Credit Spread in vertical spreads. What factors should you consider when deciding whether to trade debit or credit spreads, and when should you utilise either one?
What are the different types of vertical spread options?
In the world of options trading, vertical spread options are an often neglected yet useful tool. Buying one Put Option and selling another Put Option with the same expiration date but a higher strike price is referred to be a vertical spread strategy. Butterfly spreads and condor spreads are examples of vertical spreads. This investment approach aims to capture the time value premium of Options while lowering the risk of losing money on the trade.
Debit Spreads
Spreads in the Negative that you pay premium upfront.
Debit spreads are directional options buying methods in which you pay for an options spread net.
Example:
- Buying a put debit spread (buying a put option and then selling a put option at a lower strike price) is a directionally negative strategy.
- Buying a call debit spread, which is a bullish strategy in which you buy a call and then sell it at a higher price.
- In general, you prefer to enter debit spreads during lower IV situations.
- When net buying options or debit spreads (you pay premium), you want to do it when implied volatility is extremely low – for example, an IV rank of less than 20.
- When your IV rank is low and you enter a debit spread, one method to profit is if your IV rank rises.
- You are also more directional with your assumptions with debit spreads; the stock will either turn around or continue in the same path.
- With debit spreads, the underlying premise is that you want the stock to move.
- Debit spreads are useful for hedging since they provide immediate exposure in one direction or the other.
- For instance, if you have numerous bearish positions and need some bullish exposure, you can buy a call debit spread, which effectively gives you exposure as soon as the market continues to go higher without lag time.
- You buy these spreads at the money strikes so that as soon as the stock starts moving upward, you have immediate exposure to that stock’s upward movement.
Credit Spreads
Credit spreads are a type of net selling strategy in which you sell a spread that is out of the money.
You’ll have a higher chance of succeeding this way, but you’ll also be paying a smaller premium that is smaller profits thats is net premium received.
Example:
- Credit spreads are excellent in every situation in many ways.
- Just because debit spreads function well in low-IV situations doesn’t mean you should prefer them to credit spreads.
- Even if IV is low, the over-expectation of IV pricing, or IV edge, that you gain selling options does not go away – it simply gets lowered.
- As a result, in low IV conditions, the potential profit with predicted returns is substantially smaller.
- In low-volatility markets, you can still trade credit spreads and sell options; you just need to reduce your position size.
Scale up and assign more to the trade when IV is high. - Reduce the size of the position when the IV is low.
- Credit spreads have a lower degree of directionality than debit spreads.
- A credit spread, on the other hand, can be set up to be bullish or bearish.
- With a credit spread, however, even if the stock stays the same or falls in value, you can still profit.
Advantages of debit spread vs Credit Spread
- it carries less directional risk for an options trader.
- You take in less money because you have less directional risk.-
- Credit spreads will pay out more money in the end, with shorter drawdowns and better predicted returns.
- Credit spreads are profit-driven and react to market movements more slowly.
- Because you’re selling options and your income is capped with credit spreads, you’ll be slower to react to market movement because it’s an out of the money option.
- As a result, earnings may not be realised until much later in the expiration time.
Conclusion:
Whether we chose Debit Spread or Credit Spread, we need choosing correct strike prices. It matters a lot in both credit and debit spreads that strike prices are taken correctly like ITM, ATM, OTM based on time and IV levels.
From our experience its better to go with
1.ITM and OTM combination for Debit spreads. You make money when price moves your expected directional bias.
2. ITM and OTM combination for Credit spreads. You make money by theta decay plus your directional bias / market prediction.
Credit Spreads with OTM Strikes, questions to get answers for?
Why would you put money into a trade that requires a specific price move?
What is the current state of the market?
What is the mood of the market? (Global indicators)
What emotion do you get when you open a chart and look at your favourite indicators?
Check you trend and indicators.
Is there anything in the news or on the internet that makes you feel somewhat bullish or bearish?
Trading on News.
Which scenario is more likely?