Vertical Spreads : Short/Bear Call vs. and Long/Bear Put?

Question

I modified Kevin Ott's payoff diagrams from Call Credit Spread and Put Debit Spread that appear identical.

1. Doubtless I can see that the former credits you, and the latter debits you. But how else do these two spreads differ?

2. When ought you use the former, but not the latter?

3. When ought you use the latter, but not the former?

Answer 1

1. The payoff diagrams look similar. Where they differ is in where the strikes are relative to the underlying.

In the call credit spread, both the short call strike A, and the long call strike B are above the spot price (Spot < A < B).

In the put debit spread, the short put strike A, and the long put strike B are both lower than the spot price (A < B < Spot).

2. Use the call credit spread when you don't think the stock will appreciate more than A. You should be slightly bullish or slightly bearish. To clarify the statement of "slightly bullish", if the underlying appreciates to something less than or up to A, you collect the full premium as a gain. In other words, you collect more than the underlying appreciates. At something north of A, you start to give the premium back. If the stock doesn't appreciate much, you will earn the entire premium collected. While as the commenter seems to suggest, if the underlying depreciates, you still collect the entire premium however, you will earn less than an outright bearish position if the underlying depreciates more than the premium; so this can be seen as a slightly bearish view as well. The long call at strike B will protect you against appreciation of the stock beyond B (ie you are really wrong and the stock really appreciates). There is a breakeven point between A and B.

3. Use the put debit spread when you think the stock will depreciate more than B, but not more than A. You should be slightly bearish. If the stock depreciates as much as A, you will earn the maximum amount. Below B, you will start to earn back some of the premium you paid for the strategy. The long put at strike B will start to earn you money if the stock depreciates as much as B. There is a breakeven point between A and B, where you will have earned back the premium you paid. Any depreciation beyond that will start to earn you money and maximizes if the stock depreciates to A and beyond.

Answer 2

The call-based and put-based spreads do not differ, and the net effect of choosing either should be the same. Their payoffs are identical.

You can prove this by considering the following:

BUY 1x bear call spread @ Strike $X/$Y expiring Day D
SELL 1x bear put spread @ Strike $X/$Y expiring Day D

This means you own

+1 Call @ $Y exp Day D
-1 Put  @ $Y exp Day D
(The two above are equivalent to a synthetic long position)
-1 Call @ $X exp Day D
+1 Put  @ $X exp Day D
(The two above are equivalent to a synthetic short position)

You effectively now own nothing, since your synthetic long and short positions completely cancel out. This is a consequence of put call parity.

If the the call-based and put-based spreads differed, you could buy one and sell the other as arbitrage. No doubt, high frequency trading systems are looking out for these opportunities all the time; these opportunities probably don't exist.

So which do you choose? It is very unlikely to matter, at all. Personally, I prefer the trade that results in debit rather than credit, purely for aesthetic reasons.