What is a credit spread?
In one line: A credit spread sells one option and buys a cheaper one further out of the money, on the same stock and expiry. You collect a net credit, and the most you can lose is the width of the strikes times 100, minus that credit.
How it works
A credit spread sells one option and buys a cheaper one further out of the money, same type and same expiry. Money lands in your account the day you open it. That is the credit.
A put credit spread sells a put and buys a lower put — you want the stock to stay up. A call credit spread sells a call and buys a higher call. Both are Vertical spreads.
The number that decides whether the trade is sane is not the credit. It is the max loss: (width of the strikes × 100) − net credit.
An example that goes against you (hypothetical)
An illustration, not a trade idea. Made-up company Harbor Steel trades at $50.
- Sell the $45 put for $1.50.
- Buy the $40 put for $0.50.
Net credit: $1.00, or $100 for one spread. The strikes are $5 apart.
- Max gain: $100, if Harbor Steel stays above $45.
- Max loss: ($5 × 100) − $100 = $400.
- Break-even: $45 − $1.00 = $44.00.
Then the company loses a contract and the stock falls to $38 by expiry.
| Harbor Steel at expiry | Short $45 put | Long $40 put | Result per spread |
|---|---|---|---|
| $48 | Expires | Expires | +$100 (max gain) |
| $44 | −$100 | Expires | $0 |
| $42 | −$300 | Expires | −$200 |
| $40 | −$500 | Expires | −$400 (max loss) |
| $38 | −$700 | +$200 | −$400 (max loss) |
At $38 the short put is worth $7 and the long put $2, so the spread is $5 against you. You keep the $100 and hand back $500. The loss is $400 — four times what you collected, and the same $400 the formula gave before you opened it.
Why the credit is not the risk
This is the thing sellers get wrong, and it is the whole page. A $100 credit against a $400 max loss means four maximum wins pay for exactly one maximum loss: 4 × $100 = $400. A spread that works three times out of four has made nothing.
So:
- Size the trade on the max loss. If $400 is more than you would risk on one idea, one spread is already too big.
- Your broker holds the width, not the credit. Five $5-wide spreads tie up $2,500 of buying power.
- Spreads need a higher options approval level at most brokers, and not every Canadian TFSA or RRSP allows them — check your broker's current rules.
Where this sits next to the simpler trades is in option strategies beyond the wheel. Unlike the wheel strategy, a failed spread leaves you no shares — just the loss.
A common mistake
Letting a tested spread run to expiry because "the loss is capped anyway." The cap is real, but between the strikes the result is still being decided: at $42 the loss is $200, not $400. Closing early is how a half loss stays a half loss. Assignment on the short leg can also land before expiry.
Questions
What is the max loss on a credit spread?
The width of the strikes times 100, minus the net credit. A $5-wide spread opened for $1.00 can lose $400, whatever the credit looked like.
Isn't the credit the amount at risk?
No. The credit is the most you can make. The money at risk is the width behind it, which in the example is four times larger.
What happens if the stock finishes between the strikes?
The short leg is assigned and the long one expires, so you end up holding shares with a partial loss. That case is worked out in credit spread expires between strikes.
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