Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
There is one other concept with spreads worth noting, debits and credits:
Debits - If in trading spreads, you pay more money in one premium than you receive from the other premium, you would have a debit spread. Our example above is a debit spread. You received $1/2 dollar premium for selling 1 FAK contracts while you paid a $2 premium to buy the 1 FAJ contract. That is a $1 1/2 debit. When you have a debit spread, you are said to have bought the spread, or you are long the spread.
Credits - Credit spreads are the opposite of debit spreads in that you receive more money in premium from one option than you pay for the other. In that case you have sold the spread or you are short the spread.
Using some of the information we learned so far, we can actually calculate the maximum profit or maximum loss for certain spreads. Going back to our example of the vertical bullish spread, the maximum profit would work out to be:
FAK strike price-FAJ strike price-debit, or $55-$50-$1 1/2 = $3 1/2 per contract.
The maximum loss would be equal to the debit which is $1 1/2 per contract. For other spread positions comparable formulas can be used to determine maximum profit and loss.
There are yet many other varieties of spreads which we will omit here. If you are not feeling a little dizzy from all this so far, you are probably a professional options trader with years of experience in combinations. For the rest of us, however, spreads and straddles are as …
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