Strategy Lesson

Credit Spreads

A credit spread pairs an option you sell with an option you buy. You collect a net premium upfront, while the purchased option limits the spread's potential loss.

How Does a Credit Spread Work?

This lesson covers vertical credit spreads: two puts or two calls on the same underlying, with the same expiration and equal contract quantities, but different strike prices. Each option is called a leg. The short leg is the option you sell; the long leg is the option you buy.

You receive more for selling the short option than you pay for the long option. The difference is your net credit. That credit is the most the spread can earn before costs; receiving it does not mean you have already made a profit.

Net credit = premium received − premium paid

For standard, unadjusted equity options, multiply the per-share amount by 100 for one spread.

The Two Main Types

Put Credit Spread (Bull Put Spread)

Sell a higher-strike put and buy a lower-strike put.

Used with a neutral to bullish outlook. The desired outcome is for the stock to remain above the short put strike through expiration.

Call Credit Spread (Bear Call Spread)

Sell a lower-strike call and buy a higher-strike call.

Used with a neutral to bearish outlook. The desired outcome is for the stock to remain below the short call strike through expiration.

Worked Example: A $50/$45 Put Credit Spread

Suppose a fictional stock, XYZ, trades at $55. You open one spread using standard 100-share contracts with the same expiration:

Sell one $50 put for $1.50 per share: receive $150.
Buy one $45 put for $0.50 per share: pay $50.
Collect a net credit of $1.00 per share, or $100 total.

Maximum Profit

$100

$1.00 net credit × 100

Maximum Loss

$400

($5 width − $1 credit) × 100

Expiration Breakeven

$49

$50 short strike − $1 credit

Hypothetical prices, not live quotes or a trade recommendation. All examples exclude fees and taxes. The payoff calculations assume both legs remain intact and are settled or closed appropriately.

What Happens at Expiration?

The spread's intrinsic value is what you owe across the two legs at expiration. Subtract that amount from the $100 credit to calculate the theoretical profit or loss.

Expiration outcomes for one $50/$45 put spread opened for a $100 credit, before costs
XYZ Price	Spread Value Owed	Profit / Loss
$55	$0	+$100 (maximum profit)
$49	$100	$0 (breakeven)
$47	$300	−$200
$45 or lower	$500	−$400 (maximum loss)

At $47, the $50 short put has $3 per share of intrinsic value and the $45 long put has none. The $300 obligation minus your $100 credit leaves a $200 loss. At or below $45, the long put offsets further declines in the intact spread's payoff.

A Call Credit Spread Example

With XYZ at $55, sell one $60 call for $1.50 and buy one $65 call for $0.50, using the same expiration. You collect $100 on a $5-wide spread. Maximum profit is $100, maximum loss is $400, and expiration breakeven is $61 ($60 short call strike + $1 net credit).

At $55 at expiration, both calls are out of the money and the theoretical profit is $100. At $63, the spread is worth $300 against you, leaving a $200 loss after the credit. At or above $65, the theoretical loss reaches $400.

The Formulas to Remember

Spread width = difference between the two strike prices.
Maximum profit = net credit per share × 100 × number of spreads.
Maximum loss = (spread width − net credit per share) × 100 × number of spreads.
Put spread expiration breakeven = short put strike − net credit per share.
Call spread expiration breakeven = short call strike + net credit per share.

These formulas assume standard 100-share contracts and exclude costs. Fees reduce profit, increase loss, and shift breakeven.

Closing Before Expiration

To close the entire spread, buy back the short option and sell the long option, typically together as a spread order. If you collected $100 and pay $40 to close both legs, your profit is $60 before fees. Paying $180 to close creates an $80 loss.

Before expiration, prices depend on time remaining, volatility, and the underlying price. The expiration breakeven alone does not tell you whether closing now would make money. Wide bid-ask spreads and limited liquidity can make an exit more expensive.

Defined Risk Still Requires Management

Assignment can happen early. American-style equity options can be exercised before expiration. A short put assignment means buying shares; a short call assignment means delivering shares and can create a short stock position. The long option does not automatically exercise just because the short option is assigned.
Expiration can leave stock exposure. One leg may be exercised while the other expires, especially between the strikes or near a strike. After-hours moves and exercise decisions can create unexpected exposure. Unmanaged stock positions can lose more than the intact spread's calculated maximum loss.
Keep the protection in place. Selling the long leg while leaving the short leg open removes the spread's defined protection. Closing both legs before expiration can reduce assignment and expiration uncertainty.
Check broker requirements. Spread approval, buying power, exercise deadlines, and liquidation policies vary. Defined risk does not mean a small risk: in the examples, you risk $400 to potentially earn $100.

Key Takeaway

Credit spreads collect premium by pairing a short option with a protective long option. Put spreads favor prices staying higher; call spreads favor prices staying lower. Know both strikes, the net credit, maximum loss, and your exit plan before entering.