Credit spreads are a popular options trading strategy that traders use to generate an income. This trading strategy requires selling one option and buying another option with the same expiration date. The goal of this strategy is to profit from the difference in the premiums of the two options.

Credit Spreads Explained

Credit spreads come in two types: bullish and bearish. A trader would use a put credit spread when they are bullish. They would use a call credit spread when they are bearish. When putting on a credit spread, the option is sold out-of-the-money. This means the strike price is higher (call credit spread) or lower (put credit spread) than the current stock price. The option being bought is further out-of-the-money. This means a strike price that is even higher (call credit spread) or lower (put credit spread) than the option sold.

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By selling an option and buying a cheaper one, the trader collects a premium. The premium is difference between the two prices. This premium represents the maximum profit that can be made on the trade. The maximum loss is also limited to the difference between the strike prices of the two options, minus the premium received.

Understanding The Risk

Credit spreads are a limited-risk, limited-reward strategy. It is used to generate income in range-bound or low volatility markets. Traders can use credit spreads instead of buying and holding a stock. Credit spreads can be less risky than buying and holding a stock, as the maximum loss is known upfront.

The strategy of credit spreads can be risky. Traders should use them only if they have a solid understanding of options trading. One of the primary risks with credit spreads is the possibility of the underlying asset’s price moving against them. This can result in significant losses. Traders should have a plan for exiting the trade if the underlying asset’s price moves against them.

Brokerage Account Requirements

To trade credit spreads, a trader must have a margin account with their broker and enough capital to cover the margin requirements. Margin requirements and rules vary depending on the broker. Traders need to put up collateral to enter the trade. The collateral is equal to the difference between the two strike prices. Traders must also be aware of the expiration date of the options being traded. This will impact the potential profit and loss of the trade.

Credit spreads can be an easy way for traders to generate income and grow their account. They offer the benefit of a limited risk, with a maximum loss that is known upfront. This can make them a more attractive option for traders who want to manage their risk while still generating income. Which is favorable compared to other trading strategies that can be more risky. However, traders must be aware of the risks involved and have a solid understanding of the strategy before implementing it.

The Best Strategies For Credit Spreads

A historical return using our credit spread strategy to showcase that generating a side income with credit spreads is possible!

They can be used in a variety of market conditions. They can be used in a bullish market, bearish market, or a range-bound market. In a bullish market, traders can use a bull put spread to profit from a stock’s upward movement. Likewise, in a bearish market, traders can use a bear call spread to profit from a stock’s downward movement. In a range-bound market, traders can use a range-bound credit spread to profit from a stock’s lack of movement.

If you want to learn more about credit spreads, watch live trade examples and more, check out my Youtube channel!

Thanks for reading 🙂
Austin Bouley
CEO & Chief Strategy Officer