How a credit spread works
A credit spread sells one option and buys a cheaper one further out of the money, on the same underlying and expiry. You receive a net credit. The option you buy caps the loss, which is why the strategy is called defined-risk.
- Bull put spread: sell a put, buy a lower-strike put. Profits if the shares stay above the short strike.
- Bear call spread: sell a call, buy a higher-strike call. Profits if the shares stay below the short strike.
max profit = credit × 100
max loss = (width − credit) × 100
breakeven (put) = short strike − credit · breakeven (call) = short strike + credit
A worked example
With the figures loaded above, the shares trade at $100. You sell the 95 put and buy the 90 put for a net credit of $0.70.
- Width is $5, so the spread can lose at most $5 − $0.70 = $4.30 a share: $430 per contract. That is also the margin most brokers hold.
- Maximum profit is the $70 credit, kept if the shares finish above $95.
- Breakeven is $95 − $0.70 = $94.30, 5.7% below today’s price.
- Return on risk is $70 ÷ $430 = 16.3%, and the credit is 14% of the width.
The number most calculators leave out
A trade that risks $430 to make $70 has to win often. If every trade either kept the full credit or lost the full width, the win rate needed just to break even would be:
break-even win rate = max loss ÷ (max profit + max loss)
Here that is $430 ÷ $500 = 86%. The option prices themselves imply roughly how often the short strike finishes out of the money, so a high break-even win rate is not a flaw on its own; it is the price of selling insurance. What it does mean is that one full loss wipes out six winners, and the strategy lives or dies on avoiding the full loss.
- Credit-to-width is a quick check. Many traders look for a credit of at least a third of the width on strikes near the money. Far out-of-the-money spreads pay much less and need a correspondingly higher win rate.
- Early assignment can happen on the short leg when it is in the money, especially before an ex-dividend date for calls.
- Size from the maximum loss, not the margin or the credit. The position size calculator and the contracts guide show how.
The mirror image, paying a debit for the same structure, is in the debit spread calculator. Selling a put spread and a call spread together is an iron condor.