Net Debit

Net Debit is the cost to complete both sides of a buy-write (covered call) transaction. It is the amount you pay for buying the stock minus the amount you receive for selling the call option. It is also your break-even point.

For example, if you buy 100 shares of ABC stock for $39 and sell a call option with a strike of 40 for $2 then your net debit calculation is ($39-$2), or $37 per share. This is also your break even point on expiration day because if the stock closes above $37 on option expiration day then you have made a profit.

Your total out-of-pocket cost is $3700 (plus commissions, which we're ignoring). You pay $3900 to buy 100 shares of ABC but then you receive $200 when you sell the 1 call option with a strike of 40. Your account will be debited for a net $3700 for the day.

Our tables have a column for the Net Debit calculation. Because it is your break even point, when comparing 2 options on the same stock a lower net debit is more conservative (and will have a lower return) than a higher net debit.

Let's compare net debits for different strikes on the same underlying stock. (Note, we have upcoming sections on Time Premium and Calculating Returns; you may want to ignore those columns for now.)

Stock Price Call Strike Call Bid Net Debit Time Premium Return If Flat
39.00 30
ITM 9 points
9.40 29.60
39.00 - 9.40
0.40
ITM: 30 + 9.40 - 39
1.4%
0.40 / 29.60
39.00 35
ITM 4 points
5.20 33.80
39.00 - 5.20
1.20
ITM: 35 + 5.20 - 39
3.6%
1.20 / 33.80
39.00 40
OTM 1 point
2.00 37.00
39.00 - 2.00
2.00
OTM: 2.00
5.4%
2.00 / 37.00

Notice that the lower strikes have lower net debits (break even points) but because of this reduced risk they offer less return. Return If Flat is your return assuming the stock price doesn't change between today and option expiration (i.e. stock price is flat to expiration).

If you choose to write the 30 strike then your out of pocket cost today for 100 shares is $2960 because you pay $3900 ($39 x 100) for the stock but receive $940 ($9.40 x 100) for the option on the same day. As long as ABC stays above $29.60 (your Net Debit) by expiration you will make money. And if ABC stays above 30 (the strike price) then it will get called away and you will make 1.4% (in 1 month, if you annualize it then the annual equivalent is around 16%).

Likewise, if you choose to write the 35 strike then your out of pocket cost for 100 shares is $3380 ($3900 to buy stock minus $520 to sell a call option with strike 35). If ABC is over 33.80 on expiration day then you make money. If the stock is over 35 (strike price) on expiration day then you make 3.6% (in 1 month, annualized return = 43%).

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