Hi
If you buy a debit spread as opposed to just buying the option (without selling an OTM option) will your profit on the debit spread position increase at a slower rate?
In other words, in the following situation:
SPY trading at 170
170 CALL has a Delta of 0.5
172 CALL has a Delta of 0.25
BUY 170 CALL for $1.51
BUY 170 CALL and SELL 172 CALL for $0.84
Will my profit on the Debit spread increase at half the rate of the straight call?
If SPY trades from 170 to 171 my profit on the straight 170 CALL will be .50 cents, how do I calculate the profit on the Debit Spread now I know the delta for the two options? Do I subtract the delta of the sold strike from the bought strike (0.5-0.25) to get the delta for the whole position? So the profit on the spread will be 0.25 cents.
If I have calculated this correctly it means that although the cost basis was halved so was the profit. Is this a correct understanding?
I am asking because: Someone told me a debit spread is powerful because it decreases your cost basis, but is this a correct way to think about it? Whilst the cost to enter the position is lower, if your delta is decreased by the equivalent proportion that your costs are decreased by all you have done is lower your potential loss if both options go to 0.
If you buy a debit spread as opposed to just buying the option (without selling an OTM option) will your profit on the debit spread position increase at a slower rate?
In other words, in the following situation:
SPY trading at 170
170 CALL has a Delta of 0.5
172 CALL has a Delta of 0.25
BUY 170 CALL for $1.51
BUY 170 CALL and SELL 172 CALL for $0.84
Will my profit on the Debit spread increase at half the rate of the straight call?
If SPY trades from 170 to 171 my profit on the straight 170 CALL will be .50 cents, how do I calculate the profit on the Debit Spread now I know the delta for the two options? Do I subtract the delta of the sold strike from the bought strike (0.5-0.25) to get the delta for the whole position? So the profit on the spread will be 0.25 cents.
If I have calculated this correctly it means that although the cost basis was halved so was the profit. Is this a correct understanding?
I am asking because: Someone told me a debit spread is powerful because it decreases your cost basis, but is this a correct way to think about it? Whilst the cost to enter the position is lower, if your delta is decreased by the equivalent proportion that your costs are decreased by all you have done is lower your potential loss if both options go to 0.