SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Are Debit Spreads Better Than Credit Spreads?


Here are some misconceptions about credit spreads:

  • "One of the many drawbacks of a credit spread is that it will tie up so much capital."
  • “Selling credit spreads is like picking up pennies in front of a steam roller.”
  • "Credit spreads are different from debit spreads. One has a low probability of success, the other has a high probability of success."

I hope that after reading this article, some of those misconceptions will be cleared.

 

The trigger for this article was a conversation I had on Twitter with one of my followers. Here is a snapshot:

 

017a2e035fc42b0cc48ad650491c8be5.png

 

Same Probability? You Bet!

 

The link in my tweet pointed to one of my previous articles where I clearly demonstrated that credit spreads are in fact the same as debit spreads if using the same strikes.

 

I guess that one picture is better than thousand words, so lets try to visualize the concept.

 

Lets try to construct a RUT credit spread having ~80% probability of success. Using August 2014 expiration and July 10 closing prices, we can do the following trade:

  • Sell Aug. 2014 RUT 1210 call
  • Buy Aug. 2014 RUT 1220 call

 

The risk profile looks like this:

 

2d01dfcc7ae0f782135c4a55f388f3b3.png

 

As we can see, we get $185 credit for this trade, our margin is $815 ($1,000-185) and maximum gain is 22.7% (185/815). The maximum gain is realized if RUT stays below 1210 by August expiration.

 

As shown in the chart, the breakeven point is 1211.76 and probability of success 79.5%.

 

Now lets try to construct the same trade with puts. The trade will be:

  • Sell Aug. 2014 RUT 1210 put
  • Buy Aug. 2014 RUT 1220 put

 

The risk profile looks like this:

 

1599bf7b0f476bec2f301b293f06389e.png

 

In this trade, we are paying $815 and our margin is the same as the debit ($815). The maximum gain is realized if RUT stays below 1210 by August expiration, in which case the put spread will be worth $1,000. The maximum gain? 1000-815=185, so 185/815=22.7%, exactly the same as with the credit spread. As shown in the chart, the breakeven point is 1211.76 and probability of success 79.5% - again, exactly the same as with the credit spread.

 

There might be some practical reasons to prefer one trade over another. In our example, the credit spread is constructed using OTM (Out Of The Money) options, that tend to be more liquid and have tighter bid/ask. So while "theoretical" prices might be the same, in practice you might get better fills (which means better probability of success) with the credit spread. In addition, OTM options don't have assignment risk, while ITM options do. That means that you always have to close the ITM spreads before expiration, while with OTM spreads, you can just let them expire. Of course assignment risk is relevant only to American style options. European style options like RUT, SPX etc. can be exercised only at expiration and don't have assignment risk.

 

The bottom line:

 

The trade can be constructed by selling lower strike and buying higher strike. When using calls, we will get a credit. When using puts, we will pay a debit. But if the same strikes are used, this is exactly the same trade. Same risk profile, same maximum gain, same probability of success, same breakeven point.

 

Want to learn more about options?

 

Start Your Free Trial

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • How To Create Your Own Indexed Annuity

    Indexed annuities are a life insurance company product sold by insurance brokers for a commission that is based on the amount deposited into the contract. Contract performance is linked to popular indexes like S&P 500, and early withdrawal penalties typically apply for the first 7-10 years if withdrawals greater than 10% of the contract value are taken each year.

    By Jesse,

    • 0 comments
    • 878 views
  • Q&A with Mental Game Coach Jared Tendler

    QUESTION: Thank you for taking the time to participate in a Q & A session with Steady Option. Let’s start with an introduction and a little bit of background on who you are and how you got here.

    By Jared Tendler,

    • 0 comments
    • 1,102 views
  • Using TLT Options to Increase Expected Returns of a Buy & Hold Portfolio

    TLT is the iShares 20+ Year Treasury Bond ETF that seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. Even though US Treasuries typically act as a diversifying asset class to mainstream equities, many investors with long time horizons may not be interested in holding TLT in their portfolio because it would lower expected returns.

    By Jesse,

    • 0 comments
    • 1,315 views
  • Tax Efficient Trading Part II: Capital Gains Deferral

    In part I I illustrated how the preferential tax treatment of 1256 contracts could improve after tax returns of a PutWrite strategy over a long period of time. In this article, I’ll continue the illustration by switching from a PutWrite to an ETF BuyWrite (covered calls) strategy while holding pre-tax expected returns constant at 8%.

    By Jesse,

    • 0 comments
    • 1,618 views
  • Tax Efficient Trading Part I: The 1256 Contracts

    Cash settled index options like SPX, XSP, RUT and a few others receive special federal tax treatment where 60% of the gains are reported as a Long Term Capital Gain (LTCG) even if the contract was held for less than a year.

    By Jesse,

    • 0 comments
    • 1,600 views
  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 1 comment
    • 2,407 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 1,733 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 2,814 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 1,339 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 2,958 views

  Report Article

We want to hear from you!


Guest Ricardo Espinosa

Posted

Great explanation...if they were not the same, you could do arbitrage...buy to open a debit spread and sell the same amount of credit spreads, or the other way around. 

I tend to like short spreads because if the trend changed and the market moves against me, I can always buy to close the short leg and keep the winning long leg.

Share this comment


Link to comment
Share on other sites

They are definitely the same, however is there generally better liquidity on the in the money side, i.e. on the ITM Put Credit Spread versus the OTM Call Debit Spread?

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido