Credit Spread

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The credit spread option strategy can be used with either call options or put options.

For the most part this option spread is used when the trader placing it feels that the stock being used will not breach the short strike chosen for the spread which does make this trade somewhat of a directional play.

For example, if option trader Jane felt as though AAPL would not move above the 220 price range before the May expiration, she might decide to sell a credit spread – a bear call spread – where she sells the 220 strike call and then purchases the 230 call above it in order to ‘cover’ herself. Let’s say for this vertical spread trade she generates a 5.00 credit.

If in fact AAPL DOES stay below the 220 level all the way until expriation, Jane gets to keep the credit which could bring in a very nice return in a relatively short amount of time.

What is nice about these trades is that they give the option trader quite a lot of ‘wiggle room’ to be wrong. For example, if AAPL was at the 210 level when the above trade was initiated, Jane would make money on the trade if the the stock went down, or – went sideways, or – even if it went a little bit up (as long as it doesn’t breach the 220 strike level). This means, that out of four possible scenarios, Jane wins on this trade if the stock winds up doing three of them – and loses only if the stock does ONE of the possible scenarios.

These types of probabilities are one of the main reasons why option traders love the credit spread trade so much.