Credit Spreads

An options credit spread is an options trading strategy that involves buying and selling two options with different strike prices, but with the same expiration date. The options trader will sell one option, and buy the option with the same underlying, and expiration, only with a higher strike price.

The goal of this options trading strategy is to receive a net credit (or premium) when entering the trade. The trader hopes that the price of the underlying security will not move enough to cause the options to end up “in the money.

The Two Types of Credit Spreads

  • Bull Put Spread
  • Bear Call Spread

A bull put spread (aka “put credit spread”) is created by buying a put option with a strike price below the current market price of the underlying security, and selling a put option with a strike price below the purchased put option.

A bear call spread (aka “call credit spread”, “poor mans covered call”) is created by buying a call option with a strike price above the current market price of the underlying security, and selling a call option with same underlying and expiration, but with a higher strike price.

Risks

The maximum risk for either options strategy is the difference in strike prices minus the premium received when entering the trade. The maximum profit is equal to the premium received when entering the trade. For this reason, options traders should always consider the chances of profitability before entering a trade. Doing so will give the investor an edge, thereby allowing them a higher degree of success when trading options.

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