Chapter 20: Credit and Debit Spreads
Core idea
A spread combines a long option and a short option in the same trade. The two legs offset each other: the short leg generates premium and caps profit; the long leg pays premium and caps loss. The result is a defined-risk position where you know your maximum profit and maximum loss the moment you click “send.”
Three structural types
- Vertical — same expiration, different strikes (the focus of this chapter).
- Horizontal (calendar) — same strike, different expirations.
- Diagonal — different strike and different expiration.
Credit vs. debit, the binary that matters
A credit spread sells the more expensive option and buys the cheaper one. You collect cash up front. You profit if both options expire worthless — time is your friend.
A debit spread buys the more expensive option and sells the cheaper one. You pay cash up front. You profit if the underlying moves in your favor before expiration — direction is your friend.
The four named verticals
Combine those two dimensions with calls or puts and you get the four standard vertical spreads:
| Strategy | Type | Outlook |
|---|---|---|
| Bull put | Credit (puts) | Bullish or neutral |
| Bear call | Credit (calls) | Bearish or neutral |
| Bull call | Debit (calls) | Bullish |
| Bear put | Debit (puts) | Bearish |
Why it matters
Defined risk replaces open-ended risk
Naked option selling has theoretically unlimited loss. Adding a protective long leg converts that exposure into a known number — typically the difference between strikes minus the credit received. That bounded loss is what lets brokerages allow spreads at lower account levels than naked positions, and what lets you actually sleep at night.
Capital efficiency
A bull put spread on a $100 stock might require only $400–$500 in buying power, versus $10,000+ to buy the stock outright. Percentage returns on capital can be high, but so are percentage losses when you are wrong — size accordingly.
A strategy for every market view
Spreads are not just bullish or bearish. They can also express “the stock will go up, sideways, or only slightly down” (bull put) or “the stock will go down, sideways, or only slightly up” (bear call). That probabilistic tilt is what experienced traders mean when they say spreads are “flexible.”
Key takeaways
Key takeaways
- A spread = simultaneously buy one option and sell another — the legs offset to define both maximum profit and maximum loss.
- Vertical spreads share an expiration date but differ in strike; horizontal share a strike but differ in expiration; diagonal differ in both.
- Credit spread: collect premium, want options to expire worthless, time decay works for you. Bull put and bear call are credit spreads.
- Debit spread: pay premium, need directional move, time decay works against you. Bull call and bear put are debit spreads.
- Maximum loss on a vertical spread = width between strikes minus the net credit received (or plus the net debit paid).
- Wider distance between strikes increases both the maximum profit and the maximum loss — adjust width to express your conviction.
Mental model
Read it as: Two questions — direction and cash flow — pick the spread for you. Credit spreads (green) want time to pass with the stock staying on your side of the short strike. Debit spreads (purple) need the stock to actually travel through your long strike to a profit.
Practical application
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Form a view first. Bullish, bearish, or neutral on a specific stock over a specific horizon. The strategy comes second.
-
Pick credit or debit. If you want cash now and high odds of a small win, go credit. If you want a directional bet with smaller cost than a single long option, go debit.
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Choose strikes that match your conviction. Both legs OTM is the conservative choice. Closer-to-the-money short strikes collect more premium but lose more often.
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Set the width. A $5-wide spread risks $5 minus credit per share. A $10-wide spread risks $10 minus credit per share. Width scales both reward and risk linearly.
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Pick 30–45 day expirations for credit spreads. Theta decay accelerates in the final month — that’s the window where credit spreads earn the most per day.
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Plan the exit. Most credit traders close at 50–75% of max profit rather than holding to expiration. Most debit traders set a target (e.g. 50–100% of debit paid) and a stop (e.g. 50% of debit).
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Treat the spread as one position. Do not “leg out” of the protective option early — that turns a defined-risk trade into a naked one.
Example
A bull put spread on a stable index ETF
Suppose SPY is at $500 and you believe it will stay above $490 for the next 35 days. You open a bull put spread:
- Sell 1 SPY 490 put for $4.20 credit ($420)
- Buy 1 SPY 485 put for $2.80 debit ($280)
- Net credit: $140 collected up front
- Max profit: $140 (if SPY closes above 490 at expiration — both puts expire worthless)
- Max loss: $360 ($5 width × 100 − $140 credit, if SPY closes below 485)
- Buying power required: $360 (the max loss is the only capital at risk)
If SPY drifts sideways or rallies, time decay melts both puts and you keep the $140 — about 39% return on capital risked. If SPY drops to $487 at expiration, the 490 put is worth $3 ($300 loss on short leg) and the 485 put is worthless — net loss roughly $160. If SPY plunges to $480, both puts go ITM and the spread reaches its $360 maximum loss.
A bear call spread would mirror this exactly using calls above the current price for a bearish view.
Related lessons
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