Vertical Spreads: Credit vs Debit with Real Payoff Math

Education only. Options involve risk; not investment advice.

TL;DR

A vertical spread combines selling one option and buying another at a different strike (same expiration). Credit spreads collect premium upfront (bearish via call spreads, bullish via put spreads) but profit is capped. Debit spreads cost money upfront (bullish via call spreads, bearish via put spreads) and require the stock to move in your favor. Both cap risk and reward—making them ideal for defined-risk trading. Choose based on directional bias, IV environment, and breakeven requirements.

What’s a Vertical Spread?

A vertical spread has two legs:

1. Sell one option (collect premium)
2. Buy another option at a different strike (pay premium, cap risk)

Both options:

• Same expiration date
• Same underlying stock
• Calls or puts (don’t mix)

“Vertical” = strikes are different (horizontal = different expirations).

Four Main Types

1. Bull Call Spread (debit): Buy lower call, sell higher call → pay net debit, profit if stock rises
2. Bear Call Spread (credit): Sell lower call, buy higher call → collect net credit, profit if stock stays below
3. Bull Put Spread (credit): Sell higher put, buy lower put → collect net credit, profit if stock stays above
4. Bear Put Spread (debit): Buy higher put, sell lower put → pay net debit, profit if stock falls

Credit Spreads: Sell High, Buy Low (for Puts); Sell Low, Buy High (for Calls)

Bull Put Spread (Credit)

Example: Stock at $100

• Sell $95 put for $2.00
• Buy $90 put for $0.50
• Net credit = $1.50 × 100 = $150
• Max profit = $150 (if stock stays above $95 at expiration)
• Max loss = (Strike width − net credit) × 100 = ($5 − $1.50) × 100 = $350
• Breakeven = Short strike − net credit = $95 − $1.50 = $93.50

Payoff at expiration:

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When to use:

• Neutral to bullish on the stock
• High IV (premium is rich)
• Want to collect income with capped risk

Bear Call Spread (Credit)

Example: Stock at $100

• Sell $105 call for $2.00
• Buy $110 call for $0.50
• Net credit = $1.50 × 100 = $150
• Max profit = $150 (if stock stays below $105 at expiration)
• Max loss = ($5 − $1.50) × 100 = $350
• Breakeven = Short strike + net credit = $105 + $1.50 = $106.50

When to use:

• Neutral to bearish
• High IV
• Expect stock to stay range-bound or decline

Debit Spreads: Buy Low, Sell High (for Calls); Buy High, Sell Low (for Puts)

Bull Call Spread (Debit)

Example: Stock at $100

• Buy $95 call for $6.00
• Sell $100 call for $2.50
• Net debit = $3.50 × 100 = $350
• Max profit = (Width − debit) × 100 = ($5 − $3.50) × 100 = $150
• Max loss = $350 (debit paid)
• Breakeven = Long strike + net debit = $95 + $3.50 = $98.50

Payoff at expiration:

When to use:

• Bullish on stock
• Want to reduce cost vs. buying a call outright
• Willing to cap upside for lower risk

Bear Put Spread (Debit)

Example: Stock at $100

• Buy $100 put for $4.00
• Sell $95 put for $1.50
• Net debit = $2.50 × 100 = $250
• Max profit = ($5 − $2.50) × 100 = $250
• Max loss = $250 (debit paid)
• Breakeven = Long strike − net debit = $100 − $2.50 = $97.50

When to use:

• Bearish on stock
• Want defined risk (vs. naked short stock)
• Lower cost than buying puts outright

Credit vs. Debit: Head-to-Head

Choosing Strikes: Delta, Width, and Risk-Reward

Delta as “Probability”

• Delta ≈ probability the option finishes in-the-money (rough approximation)
• Selling a 30-delta put spread → ~30% chance the short put is ITM at expiration
• Higher delta = more credit/debit, but worse odds

Width

• Narrow spreads (e.g., $2 wide): Lower risk, lower reward, easier to size
• Wide spreads (e.g., $10 wide): Higher risk, higher reward, fewer contracts needed

Example: Same risk, different widths

• $5 wide, $1.00 credit → max loss $400 → can trade 2 contracts per $1,000 risk
• $10 wide, $2.00 credit → max loss $800 → can trade 1 contract per $1,000 risk

Risk-Reward Ratio

• Credit spreads: Aim for 1:2 to 1:3 (risk $200 to make $100 = 1:2 reward-to-risk)
  • Why? Higher probability of profit offsets lower reward
• Debit spreads: Aim for 1:1 or better (risk $250 to make $250+)
  • Need stock to move; want favorable breakeven

Selecting Strikes: A Practical Method

For Bull Put Spreads (Credit)

1. Look at support levels, recent lows, or 1 standard deviation below current price
2. Sell a put ~20–30 delta (70–80% chance of profit)
3. Buy a put 1–2 strikes lower (or $5 width for round numbers)
4. Check risk-reward: aim for credit ≥ 25–33% of width
5. Verify margin/max loss fits your account size

Example: Stock at $150, 30 DTE

• Sell $145 put (25 delta) for $3.00
• Buy $140 put for $1.00
• Credit: $2.00, Width: $5, Max loss: $3.00
• Risk-reward: 3:2 (lose $300 to make $200)
• Acceptable if probability of profit is ~75%

For Bull Call Spreads (Debit)

1. Determine target price by expiration
2. Buy a call 1–2 strikes below target (or ATM/ITM for higher delta)
3. Sell a call at or above target
4. Check debit vs. width: aim for debit ≤ 50–60% of width
5. Breakeven should be achievable given time frame

Example: Stock at $100, expect move to $110 in 45 days

• Buy $100 call for $5.00
• Sell $110 call for $1.50
• Debit: $3.50, Width: $10, Max profit: $6.50
• Breakeven: $103.50
• If stock hits $110, you make $6.50 on $3.50 risk (1.86:1)

IV Regimes: When to Prefer Credit vs. Debit

High IV Environment

• Credit spreads shine: Inflated premiums mean more credit collected
• Debit spreads are expensive (you’re buying overpriced options)
• Example: VIX > 25, earnings season, market uncertainty

Tactic: Sell OTM spreads and let theta + IV crush work for you.

Low IV Environment

• Debit spreads are cheaper to enter
• Credit spreads collect less premium (not worth the risk)
• Example: VIX < 15, calm markets

Tactic: Buy ITM or ATM spreads to capture moves with lower cost.

Normal IV (15–25 VIX)

• Either strategy works; focus on directional bias
• Compare risk-reward and breakevens

Management: Adjustments, Exits, and Rolls

When to Close Early

1. Profit target hit (e.g., collected 50–75% of max profit)
   • Remaining risk often > remaining reward
2. Stop loss triggered (e.g., loss = 2× credit or 100% of debit)
3. Time decay milestones (e.g., exit at 21 DTE or 7 DTE)
4. Volatility spike creates favorable exit

Rolling

• Roll out: Same strikes, later expiration (collect more credit, extend time)
• Roll out and down/up: Adjust strikes to improve breakeven
• Cost: Usually pay a debit to roll; must decide if it’s worth it

Example: Bull put spread breached short strike

• Current: $95/$90 put spread, stock at $92
• Roll: Close current, open $90/$85 spread at next expiration
• Goal: Reduce loss or turn losing trade into breakeven

Avoiding Early Assignment

• If short leg is deep ITM near expiration, consider closing to avoid assignment
• Early assignment rare but possible (especially before dividends)

Common Mistakes

1. Ignoring breakeven: “I collected $100 credit!” but breakeven is 5 points away
2. Too wide spreads: $20 wide = huge risk for small credit
3. Too narrow spreads: Commissions eat into $0.20 credit
4. Selling pre-earnings: IV crush helps, but gap risk is high
5. Not taking profits: Holding for max profit risks reversals
6. Wrong IV environment: Buying debit spreads when IV is 50+ percentile

Checklist: Before Entering a Spread

• Directional bias matches strategy (bullish = bull call/bull put, etc.)
• Risk-reward ratio is acceptable (credit ≥ 25% of width, or debit ≤ 60% of width)
• Breakeven is realistic given time frame and technicals
• Max loss fits position sizing rules (2–5% of account)
• IV environment supports strategy (high IV = credit, low IV = debit)
• No earnings or major events before expiration (unless intentional)
• Exit plan in place (profit target, stop loss, time-based)

FAQ

Q: Which is better: credit or debit spreads? A: Depends on IV and bias. High IV favors credit spreads. Directional conviction favors debit spreads. Both cap risk.

Q: Can I lose more than my spread width? A: No. Max loss = (width − credit) for credit spreads, or debit paid for debit spreads. Risk is defined.

Q: What’s a good risk-reward for spreads? A: Credit spreads: 1:2 to 1:3 (risk more, win less often, but higher probability). Debit spreads: 1:1 or better.

Q: Should I hold to expiration? A: Rarely. Close at 50–75% profit to reduce risk. Use stop losses to cut losses early.

Q: How do I pick the width? A: Balance risk/reward and position sizing. Narrower = easier to size, wider = fewer contracts needed. Start with $5 wide for simplicity.

Related Guides

• Naked Options 101: Risk, Margin, and When Not to Use Them
• Iron Condors: A Starter Plan for Range-bound Markets
• Greeks in Practice: The 80/20 Guide to Delta, Theta, Vega

Disclaimer: This is education only. Options trading involves significant risk and is not suitable for all investors. Consult a financial advisor before trading.