Option Strategies Details

A trader who wants to speculate on a decrease in price with a neutral to small increase in volatility can buy a Put Debit Spread. The trader pays a debit for the whole position, called a premium, though this debit is smaller than the debit associated with buying a Put alone. In exchange for this price reduction, a Put Debit Spread gives up the theoretically unlimited profit (only limited by the stock going to $0) associated with a Put as the max profit is limited to the width of the spread between the bought Put and the sold Put minus the debit paid.

Suppose stock XYZ is trading at $135. You forecast a decrease in XYZ price but only a small increase in volatility.

You buy a $130 / $125 Put Debit Spread (buying the $130 Put and selling the $125 Put) for a $1.20 debit to express this view. Your breakeven XYZ price at expiry is $130 (long Put of the spread) - $1.20 (premium paid) = $128.80, but since the time component of your trade plan may not extend all the way to expiration you should be prepared to sell to close at a variety of XYZ prices as the market value of your $130 / $125 Put Debit Spread changes. The Vega associated with a Debit Spread is much smaller than the Vega associated with a Call or Put alone because you are selling a further OTM Call or further OTM Put, and based on what we know about the Volatility Smirk (or Volatility Smirk) in equities, your position benefits from selling higher volatility.