Credit or debit spread?
Let IV decide: credit vs debit spreads
For the same bullish (or bearish) view you can sell a spread for a credit or buy one for a debit. Which one is better depends mostly on how expensive options are today.
IV Rank high (50 or more)? Sell the credit spread and let the rich premium decay. IV Rank low (30 or less)? Buy the debit spread while options are cheap. In between, the edge is small: size down or wait.
Credit spread
Best for
High IV Rank, when the premium you collect is rich against its own history.
What you get
Profit if the stock stays above the short strike; time decay and falling IV both help. Max loss is the width less the credit.
Debit spread
Best for
Low IV Rank, when options are cheap and a rise in IV would help.
What you get
Profit if the stock rises past the long strike plus the debit; rising IV helps a little. Max loss is the debit.
Side by side
| Credit spread | Debit spread | |
|---|---|---|
| Needs the stock to | Not fall below the short strike | Rise past the breakeven |
| Time decay | Helps | Hurts |
| Rising IV | Hurts | Helps a little |
| Chance of profit | Higher, smaller payoff | Lower, bigger payoff |
| Max loss | Width less the credit | The debit |
| Best IV Rank | 50 or more | 30 or less |
Why IV Rank and not IV
- IV Rank compares today's implied volatility with its own past year, so 'high' means expensive for this stock, not just volatile.
- A stock with IV of 40% can still be cheap if it usually trades at 60%.
How our backtest does it
- Vertical spread by IV checks IV Rank and the 50-day average each time it is flat.
- High IV: bull put above the average, bear call below. Low IV: bull call above, bear put below. In between it waits.
Payoff sketches are at expiry on a $100 stock, for shape only. Education, not advice: disclaimer.