I have certainly talked here about long vertical spreads quite a bit. Buying a lower strike call and selling an upper strike call if you?re bullish and buying an upper strike put and selling a lower strike put if you?re bearish. Both of these are debit spreads, meaning that you pay money to put them on.
Well, you can do the reverse or mirror image of this by way of a credit spread. Let?s say you?re bullish on XYZ, trading at 100. You could buy the 100 call and sell the 110 call against it. And let?s say you paid 5 for the 100 call and sold the 110 call for 2. You put the trade on for a 3 point debit. The P&L graph then looks like this:
The most you can lose is 3 and the most you can make is 7 if the spread goes out at its max value, 10. Now, what if you made a put credit spread out of it? Say you bought the 100 put and sold the 110 put for a 7 point credit. The P&L is exactly the same. The most you can make on expiration is if both strikes go out worthless and you make the full 7 point credit and the most you can lose is if the stock finishes lower than 100 in which case you lose 3.
This is because on expiration the vertical call spread and the vertical put spread combined will always equal the strike differential. Think about. If XYZ is at 100 or below on expiration day the 100-110 put spread expires at 10 and the 100-110 call spread at zero. With XYZ at 110 or higher the put vertical goes out at zero and the call spread goes out at 10. With XYZ at 105 both the call spread and the put spread ettle at 5.
All things being equal, I prefer credit spreads to debit spreads. I?d rather do a trade that put money in my account instead of taking it out.