Credit Spread¶
OVERVIEW¶
A credit spread is a two-legged options position where you sell one option and buy another of the same type (both calls or both puts) and same expiration, with different strike prices. The sold option is more expensive than the bought option, so cash flows into your account at open — the "credit." The purchased wing caps your maximum loss, making it a defined-risk trade. The strategy profits if the underlying stays on the favorable side of the short strike through expiration.
VARIANTS¶
| Variant | Bias | Sell | Buy |
|---|---|---|---|
| Bull Put Spread | Bullish-to-neutral | Higher-strike put | Lower-strike put |
| Bear Call Spread | Bearish-to-neutral | Lower-strike call | Higher-strike call |
KEY FORMULAS¶
| Metric | Formula |
|---|---|
| Net Credit | Premium(short) − Premium(long) |
| Max Profit | Net Credit × 100 × contracts |
| Max Loss | (Strike Width − Net Credit) × 100 × contracts |
| Breakeven — put spread | Short Put Strike − Net Credit |
| Breakeven — call spread | Short Call Strike + Net Credit |
| Return on Risk | Net Credit ÷ (Strike Width − Net Credit) |
WORKED EXAMPLE¶
SPY trades at $510. You expect it to stay above $500 for the next 30 days. You open a bull put spread:
- Sell 1 SPY $500 put @ $4.50
- Buy 1 SPY $495 put @ $2.80
- Net Credit = $1.70 per share = $170 per contract
| SPY Price at Expiration | P/L |
|---|---|
| ≥ $500 | +$170 (max profit — both puts expire worthless) |
| $498.30 | $0 (breakeven: 500 − 1.70) |
| $495 | −$330 (max loss: (5 − 1.70) × 100) |
| ≤ $495 | −$330 (max loss capped) |
Return on Risk = $170 ÷ $330 = 51.5% over 30 days if SPY holds above $500. Probability of max profit can be approximated by the short strike's delta: a 0.25-delta short put implies roughly a 75% probability of expiring out-of-the-money.
WHEN TO USE¶
| Use Case | Description |
|---|---|
| Income generation | Systematic premium collection, especially in range-bound markets |
| Defined-risk directional bets | Expressing a view without unlimited downside (unlike naked short options) |
| High-IV environments | Elevated implied volatility inflates premiums, improving credit received |
| 0DTE / weekly strategies | Fast theta decay on short-dated credit spreads |
| Margin-efficient expression | A credit spread requires far less buying power than a cash-secured short option |
Popular underlyings: SPY, QQQ, high-IV single names like TSLA and NVDA.
LIMITATIONS AND RISKS¶
Max loss is much larger than max profit
The asymmetric P/L profile — often 3x or 4x loss-to-gain ratios — means a single big loss can erase many winning trades. Position sizing is critical.
High probability ≠ low risk
A 90% probability trade still loses 10% of the time, and those losses are multiples of the wins. Expectancy, not hit rate, determines edge.
| Risk | Description |
|---|---|
| Early assignment | In-the-money short options, especially on dividend-paying stocks, can be assigned before expiration. The long leg does not automatically offset — you end up short (or long) the underlying briefly. |
| Pin risk at expiration | If the underlying closes exactly at the short strike, you don't know until after-hours whether you were assigned. Most brokers auto-close positions within $0.01 of a strike to avoid this. |
| IV crush | A spread opened in low IV bleeds less as the stock moves but also collects less premium — the math only works when IV is elevated. |