Equodity

Some easy to understand and implement strategies are debit spreads. Debit spreads, while easy can be very powerful strategies to use. First lets talk about what a debit spread is. A debit spread can be used with both calls and puts. The debit part means that you have to pay for the trade out of your account. The type, call or put would indicate the direction you want the underlying stock to move.

The reason you want to use a debit spread is because you want to decrease your risk, compared to buying the call or put alone, you want to decrease the amount of out of pocket expense for the trade or you just want to lock in profits. Let me show you an example of a call debit spread.

Potash corp of Saskatchewan, Inc ticker: POT has been one of my favorites to play lately.

Ticker	Bid	Ask	Volume	Open	Strike
PYPCK	13.2	13.5	1403	2872	155
PYPCL	9.9	10.1	2606	11349	160

In this example here I would buy the 155 calls for 13.5 and sell the 160 calls for 9.9 for a spread of 3.6. So that means each contract that I bundle together I would pay $360.00 for. The current price of the stock on Feb 25, 2008 is 164.28 and if the stock were to stay above $160 per share, I would then get the full price of the spread which in this case is $5 or $140 profit on a $360 investment. That is a 40% return on an investment that will end on March 21st 2008. The risk we have here is the stock sells off and goes under 158.60 and we start to loose what we paid for the spread.

OR

Puts, if we think POT is going to pull back over the next 30 days we can put a put debit spread.

Ticker	Bid	Ask	Volume	Open	Strike
PYPOM	7.70	7.9	852	43.3	165
PYPON	10.40	10.7	289	42.3	170

In this example I would buy the 170 puts for 10.70 and sell the 165 for 7.70 for a spread of $3.00. So that means each contract that I bundle together I would page $300.00 for. The current price of the stock on Feb 25, 2008 is 164.28 and if the stock were to stay below 165 per share I would get the full spread which in this case is $5 or $200 profit on a $300 investment. That is a 67% return on an investment that will end on March 21st 2008. The risk we have here is the stock continues to get bought up and goes over 167 and we start to loose what we paid for the spread.
OR

We can do what is called legging in. You buy the long side of the position, call or put, and you sell the short side after the stock has already moved. No you cant sell first and then buy second because you would be naked the short position and unless you know what you are doing and the broker you are using will give you that kind of credit with them, chances are they wont even let you try it, it is not recommended either. So as you might have guessed if you are right about your position after you bought the log leg, your short leg will be higher when you sell it and you will lesson the amount you had to lay out for the position.

Currently I have been trading debit spreads like this on expiration that is no shorter then 180 days and getting out with no less then 90 days to expiration. It gives me more time to be right about my trade and I dont have to worry about time decay working against me when I have just my long leg exposed.

(POT: 55.46 0.00%, vol: 0, avg vol: 18,629,200)