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intro to spreads
Introducing Defined-Risk Strategies
Learning to establish limits using vertical spreads
Long vs. Short Verticals
How do you know if a vertical will cost you a debit or bring you a credit?
Another common way traders refer to verticals is by calling them either "Debit Spreads" or "Credit Spreads." This is because they can either be sold short for a credit, or bought long for a debit. There's an easy way to know if a vertical will result in one or the other:
- Long verticals are established by selling a lower delta option, and purchasing a larger delta option - they cost a net debit
- Short verticals are established by selling a larger delta option, and buying a lower delta option – they bring in a net credit
You may recall from my
article about intrinsic and extrinsic value, that option prices grow as delta grows. If you purchase an expensive option, and sell a cheaper option, the transaction will result in a net debit. On the flip side, if you sell a higher priced option, and buy a lower priced option, the transaction will result in a net credit. Thus, you end up with either a debit or credit spread. The difference is important because it tells you how to calculate the max profit and loss for the position.
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intro to spreads
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