To profit, a credit spread needs to "narrow" or "expire." A debit spread investor wants and needs the spread to "widen" or for the options to be "exercised."
So, is the following a debit or a credit spread:
Buy 1 ABC Jan 50 call
Sell 1 ABC Jan 45 call
- Which option is worth more? The right to buy the stock for $45 or for $50? The ABC Jan 45 call is worth more than the ABC Jan 50 call
- Did the investor buy or sell that option? The investor sold the more valuable option.
- Therefore, this is a credit spread
What about this one:
Buy 1 ABC Jan 50 put
Sell 1 ABC Jan 45 put
- Which option is worth more? The right to sell stock for $50 or for $45? The right to sell stock for $50 is more valuable.
- Did the investor buy or sell that option? The investor bought that option.
- Therefore, this is a debit spread
I know, I know. Many of you friggin' hate this stuff more than you friggin' hate reading the instructions that came with your I-POD. That's normal. Unfortunately, the Series 7 is anything but, so keep grinding it out with these spreads. And feel free to submit your questions through the comments field.