Explore Your Options  |  AUG 2009

Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile DEBIT AND CREDIT What’s the difference between a debit spread and a credit spread? When investors buy or sell options, the transaction is either a debit or a credit. Of course, since an option contract is an agreement between two parties, each trade is for a debit to one party, but a credit to the other. Nevertheless, if I buy October 800 puts on the Standard & Poor’s 500 (Spx) for $3.50 per contract, I pay $3.50 per contract and that amount is a debit to my brokerage account. If Spx falls below 800 and I then sell the put for $10, I receive a credit in my account. The same principle applies to a spread. If I buy the Spx October 800 put for $3.50 and sell the Spx October 770 put for $1.00, I pay a net debit of $2.50 (or 3.50 - 1.00). I have entered a debit spread because one side of the spread costs more than the other. On the other hand, if I initiate a new position by selling the October 850 put for $10 and buying the October 800 put for $3.50, I receive a net credit of $6.50 (or 10 - 3.50). I have entered a credit spread.

by Tom Gentile