(Editors Note. We would like to welcome Dan Keegan as a contributor to the CBOE.  Dan is a well known and experienced trader.  Dan started as a runner at the CBOE in 1978, moving up to act as a Floor Broker for 5 years and then a Market Maker for 17 years.  He does mentoring for investors and sends out a weekly newsletter to subscribers.  His web-site is optionauthority.com. Welcome Dan!)

Let’s look at a call credit spread first. Apple Computer (AAPL) is trading at \$130.15. You can sell the  July 135 (all regular expiration, July 17th, and transaction costs not included) call at \$2.43. In order to define your risk you buy the July 140 call at \$1.13, thereby creating a credit of \$1.30. The maximum value for a vertical call spread is the difference between the two strike prices, in this case \$5.00.

The maximum profit is \$1.30 With AAPL at \$135 or lower, where both options are out-of-the money (OTM). The maximum loss is \$3.70 with AAPL at \$140 or higher. The breakeven point occurs at \$136.30. Losses rise with AAPL between \$136.30 and \$140, capping out at a loss of \$3.70. The July 140-145 call spread can be sold for a credit of \$0.62. That would bring in less than half of the credit of the July 135-140 call spread but with much less chance of the short call becoming in-the money (ITM).

An alternative to the AAPL 135 -140 call credit spread for a \$1.30 credit is the AAPL July 140-135 put debit spread for \$3.70. You can buy the July 140 puts for \$10.90 and sell the 135 strike puts for \$7.20. The maximum profit is \$1.30 with AAPL at 135 or lower. The maximum loss is \$3.70 at 140 or higher. The breakeven point is \$136.30. If you could buy the put spread for \$3.65 versus selling the call spread at \$1.30 then you choose the debit spread due to a \$0.05 advantage.  The credit spread and debit spread show an almost identical risk / reward.

Now let’s look at a put credit spread.  Facebook (symbol FB) is trading at \$81.01. You can sell the July 77.50 put at \$1.35. To quantify your risk, buy the July 72.50 strike put at \$0.45, thereby creating a credit of 0.90. The maximum value for a vertical put spread is also the difference between the two strike prices, in this case \$5.00.  The maximum profit is \$0.90 with FB \$77.50 or higher, where both options are out-of-the money (OTM). The maximum loss is \$4.10 with FB \$72.50 or lower. The breakeven point occurs at \$76.60 (\$77.50 less \$0.90 credit). Losses rise as FB drops below \$76.60 all the way to \$72.50, capping out at \$4.10. The FB July 67.50 - 72.50 put spread can be sold for a credit of \$0.33. That would bring in less than half of the credit of the July 72.50 - 77.50 put spread but with much less chance of the short put becoming ITM.

An alternative to the FB July 72.50 - 77.50 put credit spread for \$0.90, is the July 77.50 - 72.50 call debit spread for \$4.10. You can buy the July 77.50 calls for \$9.20 and sell the 72.50 calls for \$5.10. The maximum profit is \$0.90 with FB \$77.50 or higher. The maximum loss is \$4.10 at \$72.50 or lower. The breakeven point is FB \$76.60. If you can buy the call spread for \$4.00 versus selling the put spread at \$0.90 then you choose the debit spread due to a \$0.10 advantage.