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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
Feature | Debit Spread (Call/Put) | Credit Spread (Put/Call) |
---|---|---|
Entry Cost | Pay premium (debit) | Receive premium (credit) |
Goal | Stock moves in your favor | Stock stays in a range |
Time Decay (Theta) | Works against you | Works in your favor |
Ideal IV Environment | Low IV | High IV |
Max Loss | Net debit paid | Spread width – credit received |
Max Gain | Spread width – debit | Credit received |
Risk-Reward Ratio | Often 1:1 or 2:1 | Often 3:1 or higher |
Probability of Profit | Moderate | High (if OTM strikes chosen) |
🧠 Part 3: Vertical Spread Strategy Selection Based on Market Setup
Scenario | Recommended Spread | Why |
---|---|---|
Bullish + low IV | Bull Call Debit | Directional with cheap premium |
Bearish + low IV | Bear Put Debit | Bet on downside at low cost |
Slightly bullish + high IV | Bull Put Credit | Get paid for staying above a floor |
Slightly bearish + high IV | Bear Call Credit | Get paid for staying below resistance |
Earnings expected to be flat | Iron Condor | Premium 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!