A few weeks ago, an article discussed why options might be expensive during amateur hour. That's not the only time option prices might be expensive, of course. What if you have reason to believe that options are expensive, but you have a bias for market direction and would like to employ options to trade that bias? How could one participate in a directional move without the risk that an expensive option will leak premium even as the move occurs? Purchasing a debit spread might work in some instances.

This article is not meant to discuss all the pros and cons of debit spreads. It is instead a comparison of profits in several specific scenarios that involved options whose prices had been recently plumped up and might be in danger of losing some of that extra premium.

On August 7, one source's screening tool returned information suggesting that implied volatilities were rising in CROX's options. That implied volatility appeared to be still in the lower half of the year's range, but rising. Whether or not we consider this enough of a basis to think the options expensive, let's use CROX options as an example. This is an instance when the trader wouldn't have known whether the volatility would keep rising toward the top of its historical range, hiking options prices further, or would deflate toward recent levels. A further rise in implied volatility would help the purchaser of a put or a call, but a deflation in implied volatility would hurt the position.

A glance at CROX's six-month chart at the time quickly reveals the reason implied volatilities in CROX options might have shot higher.

Annotated Six-Month Chart of CROX as of August 7:

The speed of the upside move likely contributed to a rise in implied volatility of the options. While those traders with a bearish bent would have been salivating at the thought of a fill-the-gap drop in CROX, some traders would also have assumed that this was a breakout gap, the type that rarely gets filled. Of course, we can now look at charts and see what's happened with CROX since that chart was snapped, but this article was roughed out at the same time that chart was snapped, when no one could be sure what would happen next and which type of trader would be happiest.

Let's consider the case of a bearish trader who hoped to capitalize on a possible drop back to $4.60. We know better now, but imagine that the trader had been right on direction and target, and that the target was hit just one trading day later, on Monday, August 10, 2009. If all that had happened, would that trader contemplating a bearish trade at the close on Friday, August 8 have benefitted more by buying a single AUG 6.00 put at .85, the ask at the close, or by buying an AUG bear put debit spread?

We'll walk through this scenario and another. If you're new to all this, remember that you don't have to understand all the calculations. Pay attention only to the profits under each scenario, comparing what happens with the straight put purchase compared to the purchase of a bear put debit spread.

As of the close on Friday, the outright purchase of an AUG 6.00 put would have cost approximately $85.00 plus commissions. The purchase of an AUG 6.00 put and the selling of an AUG 4.00 put might have resulted in a debit of $73, and the purchase of an AUG 5.00 put and the selling of an AUG 4.00 put might have resulted in a debit of about $20.00. Each of these two buy/sell combinations would have created a bear put debit spread.

If CROX dropped back to $4.60 on Monday, August 10, one pricing model calculated that the AUG 6.00 put would then be worth $142.90 minus commissions, so that the profit for the trader who had bought that put for $85.00 plus commissions would be $57.90 minus commissions. On that same August 10 day, under the same conditions, the AUG 6.00/4.00 spread had a theoretical price of $132.9, resulting in a profit of $59.90 minus commissions. The trader spent less for this spread and had a higher profit. The AUG 5.00/4.00 spread had a theoretical value of $48, so anticipated a $28.00 profit after commissions. In this case, the profit was smaller, but, before commissions were considered, it was more than 100 percent of the amount spent. However, depending on the number of contracts, commissions might have eaten up a hefty proportion of the AUG 5.00/4.00 bear put credit spread's profits.

Before we draw too many conclusions, though, let's stop and reconsider. It's important to think first about what might happen with implied volatilities if CROX had dropped precipitously back to $4.60 on the next trading day, that next Monday. Typically, sharp movements raise implied volatilities, so let's include a rise of 5 percent in implied volatilities, from 104.95 percent, to 110.20 percent. [Note: when I say a rise of 5 percent in implied volatilities, I don't mean tacking an extra 5 percent onto the 104.95 percent, but rather adding 5 percent of 104.95 percent. It's always confusing when we're taking percentages of a percentage. In this case, the two calculations weren't far apart.]

Under those heightened-volatility conditions, the AUG 6.00 put would theoretically be worth $143.50, so the trader theoretically profits $58.50 on each contract, after commissions. The AUG 6.00/4.00 spread would theoretically be worth $132.20, so the trader theoretically profits $59.20 minus commissions. The AUG 5.00/4.00 spread would theoretically be worth $48.20, so the trader theoretically profits $28.20.

Do you notice anything about the profits on the spreads, when volatility stayed the same and when it rose? Profits on the spreads stayed about the same. Because a spread involves buying one option, with a bought option benefitting from a rise in volatility, and selling another option, with a sold option hurting the spread when there's a rise in volatility, the effect of changing volatility is muted with the spread.

What would this mean for the trader if CROX didn't drop precipitously that Monday, but rather took three more days to mosey down to $4.60? Implied volatility had risen August 7, but under that type of pullback scenario, implied volatility might ease a little rather than continuing to rise. Let's include an easing of 5 percent, from 104.95 percent to 99.70 percent.

The AUG 6.00 put would then theoretically be worth $140.90, so the trader theoretically profits $54.90 minus commissions. This is less than the previous profit, but some of that can be attributed to erosion of time premium, too. The AUG 6.00/4.00 bear put debit spread would theoretically be worth $135.20, offering a profit of $62.20 minute commissions. This is more profit than previously offered. The AUG 5/4 debit spread was theoretically worth $47.00, offering a profit of $27.00 minus commissions.

What's happened? Why is that AUG 6.00/4.00 bear call credit spread now so much more profitable? We already know that the buying of one option and the selling of another muted the effect of changing volatilities. The way a change in volatility impacts option prices can also be dependent how far their strike is from the current price action, too. What we haven't discussed is that when one buys one option and sells another, the sold option also changes the way the passage of time effects the prices of options trades. Long option prices are always hurt by the passage of time, and they're hurt more, the closer it is to expiration. During the period of time covered, that impact was accelerating. The long $6.00 option was leaking time premium during that period. However, so was the $4.00 option that had been sold. That sold option's erosion in price was more than offsetting the impact of the passage of time on the trade's value.

These are theoretical calculations only, and real options prices rarely exactly equal theoretical prices. These examples have also assumed options are both bought and sold at theoretical prices. Unless a vehicle is extremely liquid, that's unlikely to happen. Only a few anecdotal scenarios are discussed here, and options might behave differently in other vehicles or under different scenarios. The article also hasn't discussed the differences between the raw profit and loss and the percentage return on one's investment. Nor has it discussed all the ins and outs of a debit spread, including the risk of assignment, particularly if CROX were to drop so low that there was risk of the sold $4.00 option being assigned. All these are matters to discuss with one's broker. This is not an exhaustive examination of the merits of a debit spread over a straight put or call purchase, because such an exhaustive examination would require a chapter in a book, not a few pages in a single article.

Neither have I overloaded the article with discussions about Greeks, talking in broader terms about time value and volatility's effects. However, what should be obvious is that different options strategies, while all bearish, fared a bit differently in the same circumstances. That's the point I wanted to make.

It's a good idea for all traders to spend some time with pricing calculators or profit-loss or risk-analysis graphs, experimenting with different conditions. Your online brokerage may offer such profit-loss or risk-analysis graphs. If your brokerage doesn't, the CBOE offers an option price calculator that would allow for the kind of rough calculations I've made here. The object should be to get a feel for how different positions, each hoping to capitalize on the same move, might fare under different circumstances. Options offer us flexibility and a great variety of approaches to the same trade, but only if we learn what they can do.