5.3.1. Debit Call Spread
Suppose you open positions on the following options:
Long Sep Gold 1245 call @ 16
Short Sep Gold 1255 call @ 11
You have purchased the more expensive option of the two, so you have put out more money than you have taken in. This is a debit spread. This particular spread is a debit call spread because the two options are both calls. It is also called a bull debit spread because, as we will see, the spread turns a profit as the price of the underlying product rises.
The maximum loss for the holder of a debit call spread occurs when gold is trading at or below the lower strike price. In our example, if gold is trading below $1,245 at expiration, both options will expire, and your total losses will be fixed at the $5 difference between the two premiums. You can never lose more than the premium you pay for a debit call spread.
For a debit call spread, you calculate the breakeven by adding the difference in the premiums to the lower strike price. In this case, you will breakeven at $1,250 ($1,245 + 5).
If gold rises to $1,255, you have hit your maximum gain at $5. Why? Let’s look at the numbers when the price of gold has climbed to $1,260. The long call is in the money by $15 ($1,260 – $1,245 strike). The short call is now out of the money by $5 ($1,260 – $1,255 strike). You will take in $15 but have to pay $5. This difference is $10. You then subtract the $5 premium from the $10 for a maximum gain of $5. A quicker way to calculate this is to remember that your maximum gain is the difference in the two strike prices minus the difference in the premiums: (($1,255 – $1,245) – ($16 – $11)) = $10 – $5 = $5.
Investors purchase a bull call spread if they expect prices to rise but want to reduce the cost of a long call. With a bull call spread, an investor chooses to cap his upside potential, to reduce his premium.
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