Lesson 12: Vertical Spreads Mastery – Credit vs Debit Strategies for Defined Risk & Reward

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🎓 Lesson 12: Vertical Spreads Mastery – Credit vs Debit Strategies for Defined Risk & Reward


📌 Overview

Vertical spreads are foundational strategies that allow traders to define their risk, lower capital requirement, and express either bullish or bearish directional bias. In this lesson, we break down the two main types — Debit Spreads and Credit Spreads — and explain when and how to use each for maximum probability and reward efficiency.


🔍 Core Concepts: What is a Vertical Spread?

A vertical spread involves buying and selling two options of the same type (calls or puts), with the same expiration, but different strike prices.


🧩 Part 1: Debit Spreads (You Pay to Enter – But Profit from Movement)

Bull Call Spread

  • Buy 1 Call (lower strike)
  • Sell 1 Call (higher strike)
  • Net cost: Debit paid upfront
  • Profit if stock rises toward or beyond the upper strike

Example:

  • Stock = $100
  • Buy $100 Call @ $5.00
  • Sell $110 Call @ $2.00
  • Net Debit = $3.00
  • Max Profit = $10 (width) – $3 (debit) = $7
  • Max Return = 133% if stock closes ≥ $110 by expiry

Bear Put Spread

  • Buy 1 Put (higher strike)
  • Sell 1 Put (lower strike)
  • Net cost: Debit
  • Profit if stock falls toward or below the lower strike

Used when:

  • You’re confident in direction (bullish or bearish)
  • You want cheaper alternative to naked long calls/puts
  • Lower volatility environments (low Vega)

Dive deeper into bear and bull markets at Investopedia


🧩 Part 2: Credit Spreads (You Receive Premium – Profit from Time & Range)

Bull Put Spread

  • Sell 1 Put (higher strike)
  • Buy 1 Put (lower strike)
  • Net Credit received
  • Profit if stock stays above short strike

Used for:

  • Bullish bias with time decay edge
  • Rangebound or slightly rising markets

Bear Call Spread

  • Sell 1 Call (lower strike)
  • Buy 1 Call (higher strike)
  • Net Credit received
  • Profit if stock stays below short strike

Used for:

  • Bearish bias
  • Earnings premium selling when expecting no upside breakout
  • Ideal during high IV → Sell premium

📊 Comparison Table: Debit vs Credit Vertical Spreads

FeatureDebit Spread (Call/Put)Credit Spread (Put/Call)
Entry CostPay premium (debit)Receive premium (credit)
GoalStock moves in your favorStock stays in a range
Time Decay (Theta)Works against youWorks in your favor
Ideal IV EnvironmentLow IVHigh IV
Max LossNet debit paidSpread width – credit received
Max GainSpread width – debitCredit received
Risk-Reward RatioOften 1:1 or 2:1Often 3:1 or higher
Probability of ProfitModerateHigh (if OTM strikes chosen)

🧠 Part 3: Vertical Spread Strategy Selection Based on Market Setup

ScenarioRecommended SpreadWhy
Bullish + low IVBull Call DebitDirectional with cheap premium
Bearish + low IVBear Put DebitBet on downside at low cost
Slightly bullish + high IVBull Put CreditGet paid for staying above a floor
Slightly bearish + high IVBear Call CreditGet paid for staying below resistance
Earnings expected to be flatIron CondorPremium selling with range expectation

🧪 Real Application Example: Vertical Spreads

Stock: RTX (Raytheon Technologies)
Price: $96
Outlook: Slightly bullish based on 12-pillar score, insider buying, price targets at $105
IV Rank: 64% → elevated

Strategy: Bull Put Credit Spread

  • Sell $95 Put @ $3.50
  • Buy $90 Put @ $1.50
  • Net Credit = $2.00
  • Max Risk = $5 (spread width) – $2 = $3.00
  • Max Return = 66.7% if RTX stays above $95

📌 Probability of Profit: ~74% based on Delta of short leg
🎯 Exit Plan: 50–70% max profit OR breach below $95 with IV spike

See more real world applications that you can apply at our Stock Options Analysis & Trading Strategies!

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