COMPARISON AND CONTRAST: CREDIT SPREAD OR DEBIT SPREAD?
You may have heard me say in the past that you should use high implied volatility strategies in high implied volatility environments and low volatility strategies in low volatility environments. A credit spread is generally considered a high volatility environment play, while a debit spread is considered a low volatility environment play.
Consequently, since we're in a low volatility environment, I should be considering low volatility strategies, and pictured here is a Nov 17th 147/149 long put vertical in the November expiry. It's a bearish assumption play that costs an .82 debit to put on, has a max profit metric of 1.18/contract, and a break even of 148.18. Max profit is realized on a finish below 148.18, but I'm generally looking to manage these early, taking profit at 50% max of what I put it on for.
In comparison, a short call vertical at the exact same strikes has metrics that are virtually identical -- a Nov 17th 147/149 short call vertical brings in 1.17 credit at the mid and has a max loss .83 with a break even 148.17. For all practical purposes, the two plays have exactly the same risk.
It is consequently a myth or a basic misunderstanding that by paying for a debit spread (instead of receiving a credit for a credit spread), you're starting out "under water" or "behind the eight ball." Regardless of whether you think you're starting out "in the hole," the important thing is how much risk is present in the set up, and comparable put side/call side set ups have exactly the same risk.
So, why would I choose a debit spread over a credit spread if the metrics are exactly the same?
The answer: flexibility. Consider what would happen if price continued to rip away from your bearish assumption setup in the case of a short call vertical versus a long put vertical. In the case of the short call vertical, the short call increases in price (it becomes more "monied"), as does the long call. In the case of the long put vertical, the short put decreases in price, as does the long put (they become less "monied"). In both cases, the setups start to "go red."
Unfortunately, in the case of the short call vertical, there's not much you can do to take advantage of the situation besides wait (you can roll the long call away from current price to lock in its increase in value, but this widens the spread, and therefore increases your risk and buying power reduction). With the short put vertical however, you can potentially "work it" intra-expiry without increasing your risk and to potentially mitigate loss, and that is by rolling the short put toward current price on the options decrease in value, rolling a long put vertical into a narrower vertical or rolling what was a long put vertical into a short put vertical. Naturally, you want to do any rolls like sparingly and mechanically (e.g., roll the short put to the 30 delta at 30 days until expiry) ... .
Consequently, since we're in a low volatility environment, I should be considering low volatility strategies, and pictured here is a Nov 17th 147/149 long put vertical in the November expiry. It's a bearish assumption play that costs an .82 debit to put on, has a max profit metric of 1.18/contract, and a break even of 148.18. Max profit is realized on a finish below 148.18, but I'm generally looking to manage these early, taking profit at 50% max of what I put it on for.
In comparison, a short call vertical at the exact same strikes has metrics that are virtually identical -- a Nov 17th 147/149 short call vertical brings in 1.17 credit at the mid and has a max loss .83 with a break even 148.17. For all practical purposes, the two plays have exactly the same risk.
It is consequently a myth or a basic misunderstanding that by paying for a debit spread (instead of receiving a credit for a credit spread), you're starting out "under water" or "behind the eight ball." Regardless of whether you think you're starting out "in the hole," the important thing is how much risk is present in the set up, and comparable put side/call side set ups have exactly the same risk.
So, why would I choose a debit spread over a credit spread if the metrics are exactly the same?
The answer: flexibility. Consider what would happen if price continued to rip away from your bearish assumption setup in the case of a short call vertical versus a long put vertical. In the case of the short call vertical, the short call increases in price (it becomes more "monied"), as does the long call. In the case of the long put vertical, the short put decreases in price, as does the long put (they become less "monied"). In both cases, the setups start to "go red."
Unfortunately, in the case of the short call vertical, there's not much you can do to take advantage of the situation besides wait (you can roll the long call away from current price to lock in its increase in value, but this widens the spread, and therefore increases your risk and buying power reduction). With the short put vertical however, you can potentially "work it" intra-expiry without increasing your risk and to potentially mitigate loss, and that is by rolling the short put toward current price on the options decrease in value, rolling a long put vertical into a narrower vertical or rolling what was a long put vertical into a short put vertical. Naturally, you want to do any rolls like sparingly and mechanically (e.g., roll the short put to the 30 delta at 30 days until expiry) ... .
Comment:
There is one additional benefit that people frequently overlook and that is "assignment risk avoidance," particularly around ex-divvy where in-the-money call side assignment risk is heightened.
Comment:
I would note that just because an intratrade roll is available with these doesn't mean they'll be "automatic" winners if you do an intratrade roll. However, it does have the potential for mitigating loss since any credit received for a roll up of the short put will decrease your cost basis in what you paid to put it on -- an option you don't have with a short call vert, generally.