Credit Spread

What is Credit Spread?

Credit Spread A credit spread is a defined-risk premium-selling strategy that involves selling a closer-to-the-money option and buying a further out-of-the-money option as protection. The trader collects net credit (premium received exceeds premium paid). The position profits if the underlying moves favorably or stays put; max loss is capped at the wing width minus the credit. Two types of credit spreads: **Bull put credit spread (bullish/neutral):** - Sell 1 OTM put (higher strike) - Buy 1 further OTM put (lower strike, protection) - Net credit collected - Profits if underlying stays above the short put strike - Use when bullish or neutral, prefer high IV environments **Bear call credit spread (bearish/neutral):** - Sell 1 OTM call (lower strike) - Buy 1 further OTM call (higher strike, protection) - Net credit collected - Profits if underlying stays below the short call strike - Use when bearish or neutral, prefer high IV environments Worked example bull put credit spread: SPY at $540, 30 DTE - Sell 1 SPY $530P at $2.10 - Buy 1 SPY $525P at $1.10 - Net credit: $1.00 ($100 per contract) - Max profit: $100 if SPY closes above $530 - Max loss: $5 wing − $1 credit = $400 - Break-even: $529 (short strike − credit) - POP at entry: ~70% with 16-delta short strike - Reward-to-risk: 0.25× (collect $100, risk $400) Credit spreads are the building blocks of more complex strategies. Two credit spreads on opposite sides = iron condor. Three credit spreads = iron condor with additional safety. The mechanics scale to any structure that combines short and long options at different strikes. When credit spreads work: - **IV rank above 50** — premium is rich enough to justify the locked capital - **Directional or neutral views** — choose put credit spread for bullish, call credit spread for bearish - **30-45 DTE entries** — sweet spot for theta accrual vs gamma risk - **Close at 50% of max profit** — captures most of the available premium with much less gamma exposure When credit spreads fail: - **Wrong direction** — underlying moves past the short strike, accelerating losses - **Vol expansions** — short-vega position hurt by rising IV - **Hold-to-expiration** — gamma risk inside 14 DTE converts winners into losers The credit spread's main appeal vs naked premium selling is the capped max loss. Selling a naked put on a $530 SPY put would require $53,000 in collateral and expose the seller to $53,000 worst-case loss. The same trade as a 5-wide credit spread requires $400 capital and caps loss at $400. The premium collected is smaller, but the risk-adjusted return is dramatically better.