Posted in Finance, Accounting and Economics Terms, Total Reads: 256
Definition: Debit Spread
It results when an investor buys an option that has a higher premium than that of a option which an investor sells at almost a same point of time. The two options that an investor trades have different market prices on the same underlying security. The initial cash outflow will be greater in case the debit spread is higher.
For example, suppose an investor sells a call option at Rs.100 and immediately afterwards buy a call option at Rs.125. The debit spread in this case would be Rs. 25, which results in initial loss of Rs.2500 (25*100)
Taking position in the long side (buying the option) of the market, offers unlimited potential benefits with risk limited to the extent of premium paid for the option. Whereas taking position in the short side (selling the option) of the market, reverses the situation, that is, unlimited potential losses with limited potential profits. By selling and buying options at the same time an investor not only limits his maximum profits but also put a cap on the maximum loss he can incur.