Income Strategy · Defined Risk

Credit Spreads

Collect premium with a built-in safety net. Credit spreads let you express a directional view — bullish or bearish — while capping your maximum possible loss from the start.

Risk LevelDefined

IncomeModerate

Capital Req.Spread Width × 100

Time FrameDays–Weeks

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The Basics

What Is a Credit Spread?

A credit spread is a two-leg options trade where you sell one option and buy another at a different strike — same expiration, same underlying. You collect a net credit upfront (hence the name).

The option you buy acts as insurance, capping your maximum loss no matter how far the stock moves against you. This is what makes credit spreads "defined risk" trades.

There are two main types:

Bull Put Spread — Bullish/neutral. Sell a higher put, buy a lower put. Profit if stock stays above the short strike.
Bear Call Spread — Bearish/neutral. Sell a lower call, buy a higher call. Profit if stock stays below the short strike.

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The core idea: You're collecting premium with a defined max loss — great for traders who want consistent income without the unlimited risk of naked options.

Key Terms

Short Strike

The option you sell. This generates the premium. Your directional level — stock should stay on the profitable side of this.

Long Strike

The option you buy for protection. Caps your maximum loss at the spread width minus the credit received.

Net Credit

What you collect upfront. Premium received from short − premium paid for long.

Spread Width

Distance between strikes × 100 = maximum possible loss per contract.

Max Loss

(Spread width − net credit) × 100. Known before you enter the trade.

Walk-Through

Bull Put Spread Example

SPY is trading at $490. You're bullish and don't think it will drop below $475 in the next 30 days.

You sell the $475 put for $3.20 and buy the $465 put for $1.25. Net credit: $1.95/share = $195 per contract. Max loss: ($10 spread − $1.95) × 100 = $805.

Wait for expiration:

✓ SPY stays above $475

Both puts expire worthless. Keep the full $195 credit. That's a 24% return on the $805 at risk.

+$195 (24% ROC)

→ SPY between $473 and $475

In the loss zone but above full max loss. Can close early to limit damage.

Partial loss

⬇ SPY falls below $465

Max loss reached. Long put kicks in — you lose no more than $805 no matter how far it falls.

−$805 max loss

Profit & Loss

The P&L Profile

Bull Put Spread — profit above short strike, max loss below long strike.

Max profit zone — stock above short strike

Loss zone — between breakeven and long strike

Short strike — where you collected premium

Strategy

When to Use It

You have a directional view but want capped risk
You don't have enough capital for a cash-secured put
Implied volatility is high — more premium to collect
You want defined max loss before entering the trade
You're trading in a smaller account (IRA, Roth, etc.)

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Risk/reward reality: Most credit spreads risk $3–$5 to make $1. That's fine — your win rate just needs to be high enough. Target 70%+ probability of profit at entry.

Metrics

What to Target

~30%

Credit / spread width

Collecting 30% of the spread width is a solid target — e.g., $3 on a $10 wide spread.

70%+

Probability of profit

Short strike should be OTM with ~30 delta or less for high win rate.

21–45

Days to expiration

Close at 50% profit or when 21 DTE is reached to avoid gamma risk.

2:1

Loss:Profit management

Cut losses when spread reaches 2× the credit received to protect capital.

Honest Assessment

Pros & Cons

✓ Pros

Defined max loss — know your risk before you enter
Less capital required than cash-secured puts
Works in smaller accounts and IRAs
High probability of profit trades available
Theta decay works in your favor as seller
Can be used bullishly or bearishly

✗ Cons

Lower premium than naked options
Risk/reward is skewed — risk more than you make
Two commissions (two legs) per trade
Can still lose the full spread width on a big move
Requires managing both legs at close