The Interrelations of Credit
Spreads and Debit Spreads
Many traders I know specialize in certain niches. Sometimes this is because
they find something they know well and are really good at. Sometimes it’s
because they have become comfortable and don’t have the desire to try
anything new. I’ve seen this strategy specialization sometimes with traders
trading credit spreads and debit spreads. I’ve had serial credit spread traders
tell me credit spreads are the best trades in the world, much better than debit
spreads. Habitual debit spread traders have likewise said their chosen
spread is the best. But credit spreads and debit spreads are not so different.
In fact, one could argue that they are really the same thing.
Conventionally, credit-spread traders have the goal of generating income.
The short option is usually ATM or OTM. The long option is more OTM.
The traders profit from nonmovement via time decay. Debit-spread traders
conventionally are delta-bet traders. They buy the ATM or just out-of-the-
money option and look for movement away from or through the long strike
to the short strike. The common themes between the two are that the
underlying needs to end up around the short strike price and that time has to
pass to get the most out of either spread.
With either spread, movement in the underlying may be required,
depending on the relationship of the underlying price to the strike prices of
the options. And certainly, with a credit spread or debit spread, if the
underlying is at the short strike, that option will have the most premium.
For the trade to reach the maximum profit, it will need to decay.
For many retail traders, debit spreads and credit spreads begin to look
even more similar when margin is considered. Margin requirements can
vary from firm to firm, but verticals in retail accounts at option-friendly
brokerage firms are usually margined in such a way that the maximum loss
is required to be deposited to hold the position (this assumes Regulation T
margining). For all intents and purposes, this can turn the trader’s cash
position from a credit into a debit. From a cash perspective, all vertical
spreads are spreads that require a debit under these margin requirements.