Video Summary (3 minutes)
By turning an outright option like call or a put into a call or put debit spread, the buyer can lower the cost of their trade and create a breakeven closer to where the stock is trading and being somewhat less reliant on outsized moves. The tradeoff for that is the spread has a max gain after a certain-sized move. Before we get to examples of debit spreads, let’s discuss the Expected Move, because it’s particularly illustrative here.
The expected move is the amount that a stock is expected to move up or down from its current price. It’s the consensus, at that moment, based on buyers and sellers of options. One way to think about the expected move is: If the stock stays within the Expected Move, options were overpriced, if the stock goes beyond the expected move, options were underpriced. If the stock moves in line with the expected move, options were properly priced. Knowing this consensus before making a trade can be incredibly powerful, particularly with strike selection on spreads.