A credit spread sells one option and buys another, further away, of the same type and expiry. You receive money upfront, and the bought option caps how much you can lose.
The two standard versions are the bull put spread and the bear call spread. They are popular because they win more often than they lose. That fact is true and also misleading, and this article explains both halves.
The two spreads
Bull put spread — for a view that the price will stay above a level:
Sell a put option at a strike below the current price.
Buy a put option at a lower strike.
If the price stays above the sold strike until expiry, both options expire worthless and you keep the credit.
Bear call spread — for a view that the price will stay below a level:
Sell a call option at a strike above the current price.
Buy a call option at a higher strike.
If the price stays below the sold strike until expiry, both expire worthless and you keep the credit.
In both, the bought option is the protection. Without it, the position would be a naked short option with very large potential losses. With it, the maximum loss is fixed at the distance between the strikes minus the credit received.
These are the credit counterparts of the debit spreads — the bull call spread and bear put spread. A bull put spread and a bull call spread express the same broad view; one collects money and benefits from time passing, the other pays money and needs the price to move.
A worked example
Suppose an index is at 24,000 and you expect it not to fall below 23,800 over the next two weeks. Illustrative prices:
Sell the 23,800 put option at 90.
Buy the 23,600 put option at 45.
Net credit: 90 − 45 = 45 points per unit. Multiply by the lot size for rupees.
At expiry, above 23,800: both expire worthless. Profit: 45, the maximum.
At expiry, below 23,600: the spread is worth its full width of 200. Loss: 200 − 45 = 155, the maximum.
Breakeven: 23,800 − 45 = 23,755.
Notice the shape. The maximum profit is 45; the maximum loss is 155. You are risking more than three times what you can make. The trade is attractive only because the price is more likely to stay above 23,755 than to fall below it — perhaps considerably more likely.
That is the defining trade-off of credit spreads: a high probability of a small gain against a lower probability of a larger loss. Over many trades, one full loss can erase the profit from three or four wins. Whether the strategy works depends on how often the losses occur and how large they are allowed to become, not on the win rate alone.
How they behave before expiry
Time works for you. The sold option loses value faster than the bought one as days pass, so the spread's value falls and your profit rises even if the index does not move.
Volatility works against you. A rise in implied volatility increases the value of both options, but generally affects the sold, nearer option more, raising the cost of closing the spread. A sharp fall in the market often comes with a rise in volatility — a double hit for a bull put spread.
Price movement toward the sold strike hurts quickly. As the index approaches the sold strike, the spread's value rises fast. Near expiry, small moves around that strike cause large changes in the position.
Margin is lower than a naked sale, because the maximum loss is defined — but only once both legs are in place. Enter both together as a single order where your broker allows it; selling first and buying the protection later leaves you briefly holding a naked position.
Index options in India are cash-settled at expiry, so there is no delivery. Stock options are different: if a stock option spread ends with the sold leg in the money, it can lead to physical settlement obligations, which need planning well before expiry.
Managing a credit spread
Take profit before expiry. A common practice is to close once a large share of the maximum profit — often around half — has been captured. The remaining profit is small; the remaining risk, concentrated in the final days, is not.
Decide the loss exit in advance. For example, close if the spread's value reaches a set multiple of the credit received, or if the index crosses a level. Writing this at entry prevents the most common failure: watching a spread go from small profit to maximum loss while hoping for a recovery.
Avoid rolling to avoid a loss. Moving a losing spread to a later expiry can be reasonable if you would open the new position on its own merits. If its only purpose is to avoid booking a loss, it usually just extends the exposure.
Size by the maximum loss, not the credit. The number that matters for sizing is the 155 in the example, not the 45. Size so that a full loss on any single spread is an amount you can accept.
Count the costs. Two legs, each with charges and a bid-ask spread, on entry and exit. On small credits, costs are a meaningful share of the maximum profit.
An account with basket orders and a margin calculator
See the hedged margin and place both legs in one go. Free to open
Prices in the example are illustrative, not market data. Lot sizes, margin rules, settlement rules and charges are set by the exchanges and SEBI and change from time to time. This is educational material, not advice, and no position is recommended. We run no tips group and no signal service, we manage nobody's money, and no return is promised. Derivatives can lose more than the amount blocked against them.
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Frequently Asked Questions
What is a credit spread?
An options structure that sells one option and buys another further away, of the same type and expiry, receiving a net credit upfront. The bought option caps the maximum loss.
What is the difference between a bull put spread and a bear call spread?
A bull put spread sells a put option and buys a lower one, profiting if the price stays above the sold strike. A bear call spread sells a call option and buys a higher one, profiting if the price stays below the sold strike.
How do I calculate the maximum loss on a credit spread?
The distance between the two strikes minus the credit received, multiplied by the lot size. In a 200-point spread with a 45-point credit, the maximum loss is 155 points per unit.
Why do credit spreads win often but still lose money?
Because the maximum loss is usually several times the maximum profit. One full loss can erase several wins, so results depend on how often losses happen and how large they are allowed to get.
When should I close a credit spread?
Many traders close once a large share of maximum profit, often around half, has been captured, and set a loss exit in advance. Holding to expiry for the last small profit concentrates risk in the final days.
Related Reading
- The options course, for Lucknow
- The debit spread versions
- When a spread has an extra sold leg
- Stock option spreads near expiry
- Two credit spreads combined
- Sizing by the maximum loss
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
