Credit Spread

A credit spread is an options strategy with two legs, the mirror image of a debit spread. You sell one option and buy another of the same type and expiration but at a different, further-away strike. You collect more for the option you sell than you pay for the one you buy, so you receive a net amount up front. That amount is the credit.

The credit is the most you can make on the trade. Your risk is defined too: the distance between the two strikes minus the credit you collected.

A bull put spread sells a put at a higher strike and buys a put at a lower strike. It profits if the stock stays above the short strike, so it is used when you expect the stock to rise or just hold steady. A bear call spread sells a call at a lower strike and buys a call at a higher strike, profiting if the stock stays below the short strike.

A stock trades at $100. You sell a $95 put for $2.50 and buy a $90 put for $1.00, a bull put spread. The net credit is $1.50 per share, or $150 per contract of 100 shares. That $150 is the most you can make.

Your most you can lose is the $5 gap between the strikes minus the $1.50 credit, which is $3.50 per share, or $350, if the stock finishes at or below $90. Between $90 and $95 the loss is smaller. Above $95, both puts expire worthless and you keep the full $150. These are made-up numbers before commissions.

Credit spreads profit as time passes and options lose extrinsic value, and they can profit even if the stock does not move at all, as long as it stays on the right side of the short strike. That is different from a debit spread, which usually needs the stock to move to profit.

The trade-off is that the maximum profit is often smaller than the maximum loss, so the position needs to win most of the time to be worthwhile over many trades. The short leg can also be assigned early on American-style options. Signal Desk's Options tab can build these spreads with live quotes and chart their payoff.