A Call Debit Spread is an options trading strategy that involves buying a call option and, simultaneously, selling another call option with a higher strike price. This strategy is used when an investor is moderately bullish on the underlying asset’s price but wants to limit their initial investment cost.
How Call Debit Spread Works:
In a Call Debit Spread, you buy a call option with a lower strike price (closer to the current market price) and sell a call option with a higher strike price. Both options have the same expiration date. Since you are buying and selling call options, it’s called a “debit” spread because you pay a net premium for the trade.
Example of Call Debit Spread:
Let’s assume that stock XYZ is trading at $50 per share, and you believe the stock’s price will rise moderately in the near term. To implement a Call Debit Spread:
Step 1: Buy a Call Option
- Buy a call option with a strike price of $50 (At-The-Money or close to the current stock price).
- This option gives you the right to buy XYZ shares at $50 each until the expiration date.
Step 2: Sell a Call Option
- Simultaneously, sell a call option with a strike price of $55 (Out-Of-The-Money or higher than the current stock price).
- This option obligates you to sell XYZ shares at $55 each until the expiration date if the option is exercised.
Potential Outcomes at Expiration:
- If the stock price rises significantly above $55:
- The call option you bought (with a strike price of $50) will be “In-The-Money” and have value.
- The call option you sold (with a strike price of $55) will also be “In-The-Money” and have value, but you are obligated to sell the shares at $55, limiting your profit potential.
- If the stock price stays between $50 and $55:
- The call option you bought (with a strike price of $50) will be “In-The-Money” and have value, but the call option you sold (with a strike price of $55) will expire “Out-Of-The-Money” and become worthless.
- Your potential profit will be the difference between the strike prices ($55 – $50) minus the net premium paid for the spread.
- If the stock price falls below $50:
- Both the call options will expire “Out-Of-The-Money,” and you will lose the premium paid for the spread.
Key Takeaways:
- Call Debit Spread is a moderately bullish strategy used to limit the initial investment cost while still benefiting from a rise in the stock price.
- It’s essential to consider the stock’s price movement, the cost of the spread, and the potential profit and loss scenarios before executing this strategy.
As with any options strategy, it’s crucial to understand the risks involved and consider consulting with a financial advisor before implementing Call Debit Spread or any other options trading strategy.