Credit Spread

Credit spreads come in two flavors depending on your directional bias.

Bull put spread (bullish): Sell a put at a higher strike and buy a put at a lower strike, same expiration. You collect a net credit and profit if the stock stays above the short put strike at expiration. Example: Stock at $150. Sell the $145 put for $3.00, buy the $140 put for $1.50. Net credit = $1.50. Max profit = $1.50 (if stock stays above $145). Max loss = $3.50 (spread width $5 minus credit $1.50, if stock falls below $140).

Bear call spread (bearish): Sell a call at a lower strike and buy a call at a higher strike. You collect credit and profit if the stock stays below the short call strike. Example: Stock at $150. Sell the $155 call for $2.50, buy the $160 call for $1.00. Net credit = $1.50. Max profit = $1.50 (if stock stays below $155). Max loss = $3.50.

Both strategies have defined risk — your maximum loss is always the spread width minus the credit received. This makes credit spreads accessible to smaller accounts and easier to manage psychologically than naked options.

Strike selection is the most important decision in a credit spread.

Delta as probability proxy: The short strike's delta roughly approximates the probability of the option expiring in-the-money. A 0.20 delta short put has approximately a 20% chance of being breached — meaning an 80% probability of profit. More aggressive traders sell at 0.30 delta (70% POP); conservative traders use 0.15 delta (85% POP).

Spread width: Wider spreads collect more premium but have higher max loss. A $5-wide spread might collect $1.50 (risking $3.50). A $2.50-wide spread might collect $0.80 (risking $1.70). Narrow spreads have better risk/reward ratios but lower absolute premium.

Expiration selection: 30-45 days to expiration (DTE) is the sweet spot. Theta decay accelerates in this window, benefiting premium sellers. Shorter DTE (under 14 days) has faster decay but less room for error — adverse moves can push you to max loss quickly. Longer DTE (60+ days) collects more premium but ties up capital and gives the stock more time to move against you.

IV environment: Credit spreads perform best in high IV environments (IV rank above 50). High IV inflates option premiums, meaning you collect more credit for the same delta level. When IV subsequently contracts (IV crush after earnings, for example), the spread's value decreases — which is profitable for the seller.

Managing credit spreads after entry is where most traders make or lose money.

Profit target: Close at 50-75% of max profit. If you collected $1.50 credit, buy back the spread when it's worth $0.375-$0.75. Holding to expiration for the last 25% of profit exposes you to gamma risk and pin risk for minimal additional gain.

Stop-loss: Close if the spread reaches 1.5-2x the credit received. If you collected $1.50, close at $2.25-$3.00 loss. This limits drawdown and preserves capital for future trades.

Rolling: If the stock moves against you but your thesis hasn't changed, you can "roll" the spread — close the current position and open a new one at a further expiration or different strikes. Rolling out in time (same strikes, later expiration) collects additional credit and gives the trade more time. Rolling down/up (adjusting strikes) reduces risk but also reduces potential profit.

Assignment risk: If the short option goes deep in-the-money, early assignment is possible (especially near ex-dividend dates for calls). The long option protects you — exercise it to offset the assignment. Most brokers handle this automatically, but monitor positions approaching expiration with the short leg in-the-money.

Earnings warning: Avoid holding credit spreads through earnings unless the trade is specifically designed as an earnings play. The gap risk from earnings can blow through both strikes overnight, resulting in maximum loss.