A credit spread is an options strategy where you sell an option at one strike price and simultaneously buy an option at another strike price (further out-of-the-money), collecting a net credit as profit if the stock stays within a defined range.
How Credit Spreads Work
Example: Selling a call spread on INFY
INFY is trading at ₹1,900. You believe it won’t rally above ₹2,000 in the next month.
Your setup:
- Sell 1 INFY ₹1,950 call option → Collect ₹50 premium
- Buy 1 INFY ₹2,000 call option → Pay ₹20 premium
- Net credit: ₹50 - ₹20 = ₹30 (your profit if price stays below 1,950)
You received ₹30 per share upfront. That’s your profit to keep if INFY stays below ₹1,950 at expiration.
Maximum Profit and Loss
Maximum Profit:
- ₹30 per share (the net credit you collected)
- Profit is realized if INFY closes below ₹1,950
- Example: INFY at ₹1,920 at expiration = you keep ₹30
Maximum Loss:
- (2000 - 1950) - 30 = ₹20 per share
- Loss happens if INFY rallies above ₹2,000
- Example: INFY at ₹2,050 at expiration = you lose ₹20
Why limited loss? The long call (2000 strike) protects you. If INFY rallies past 2000, your long call caps the loss. Without it (naked short call), you’d lose unlimited amounts.
Call Spread vs. Put Spread
Credit spreads work for both calls and puts:
Call spread (bullish to neutral):
- Sell a call, buy a higher call
- Profit if stock doesn’t rally too much
- Used when you’re neutral or slightly bullish
Put spread (bearish to neutral):
- Sell a put, buy a lower put
- Profit if stock doesn’t fall too much
- Used when you’re neutral or slightly bearish
Both collect credit upfront.
Why Traders Use Credit Spreads
1. Defined risk You know your max loss before entering. Unlike a naked short call (unlimited loss), a spread caps it.
2. High probability of profit You profit if the stock goes slightly up, stays flat, or falls. You lose only if it makes a large move against you.
3. Better use of margin Selling a naked call requires more margin. A spread requires less margin (because you own the protective long call).
4. Theta decay works for you As time passes, both options lose value, but your short option loses faster. Your credit erodes slowly; their profit erodes quickly.
Real Example: INFY Call Spread Trade
Setup (30 days to expiration):
- INFY stock: ₹1,900
- Sell ₹1,950 call: ₹50
- Buy ₹2,000 call: ₹20
- Net credit: ₹30
- Risk: ₹20 per share (strike difference minus credit)
- Profit if INFY < ₹1,950 at expiration
10 days later:
- INFY stock: ₹1,920 (moved up slightly)
- Sell ₹1,950 call: Now worth ₹35 (decayed from ₹50)
- Buy ₹2,000 call: Now worth ₹12 (decayed from ₹20)
- Net credit to close: ₹35 - ₹12 = ₹23
If you close early:
- You collected ₹30 when you opened
- You paid ₹23 to close
- Profit: ₹30 - ₹23 = ₹7 per share
You took 50% of your max profit in 10 days with minimal time remaining. Smart traders close when they’ve won 50-70% of the credit; no need to wait until expiration.
Common Credit Spread Mistakes
1. Too tight spreads
- Sell 1950, buy 1960 spread (₹10 wide)
- Collect only ₹3 net credit
- Risk ₹7 to make ₹3 (2.3:1 risk/reward)
Better: Spread should be at least ₹15-20 wide to justify the risk.
2. Selling too close to current price
- INFY at 1900, sell 1910 call
- Only 10 pips of cushion before you hit max loss
- One 15-pip rally and you’re at max loss
Better: Sell strikes 3-5% out of the money, not 0.5%.
3. Not closing early
- Collect ₹30, wait until expiration
- Take profit at 50%: Close at ₹15 cost, keep ₹15 profit
- Why risk losing ₹25 to make ₹30?
Better: Close at 50-70% profit, move to next trade.
4. Rolling down into losses
- Trade goes bad, stock rallies past your short strike
- Instead of taking the ₹20 loss, you “roll” to a lower strike
- This typically results in bigger losses
Better: Accept small losses and move on.
Credit Spreads on Earnings
Credit spreads are dangerous around earnings. IV crush works against you.
Pre-earnings:
- IV is high
- Options are expensive
- Your credit spread collects fat premiums
Post-earnings:
- IV crashes
- Options become cheap
- Your short call decays less than expected
- Your long call’s loss is offset partially by IV decay
In IV crush scenarios, closing at 50% profit becomes harder. The spread might only decay to 70% instead of 30%.
The Margin Requirement
Credit spreads require less margin than naked shorts:
| Strategy | Max Loss | Margin Req. |
|---|---|---|
| Naked short call | Unlimited | Very high |
| Call spread (₹50 wide) | ₹50 per share | Lower |
| Put spread (₹50 wide) | ₹50 per share | Lower |
Most brokers require margin equal to the max loss of the spread.
Example: Your ₹1,950-₹2,000 call spread has max loss of ₹20. Broker requires ₹20 per share as margin = ₹2,000 for 100-share contract.
Probability of Profit
Credit spreads have high probability of profit because you profit in multiple scenarios:
Call spread (1950/2000):
- Profit if stock ↓ (stay below 1950)
- Profit if stock → (stay at current level)
- Profit if stock ↑ up to 1950
- Lose if stock ↑ above 2000
That’s roughly 60-70% of possible outcomes (unless the stock is near the short strike).
When to Use Credit Spreads
Use credit spreads when:
- You want defined risk
- You want to reduce margin requirement
- You’re neutral to slightly bullish/bearish
- You want to profit from time decay (theta)
- IV is elevated (higher premiums to sell)
Avoid credit spreads when:
- You’re strongly directional (use outright calls/puts instead)
- IV is very low (premiums too small to justify the risk)
- You’re trading earnings or binary events (IV crush destroys spreads)
Iron Condor: Double Credit Spread
An iron condor is two credit spreads combined:
- Sell a call spread (bullish side)
- Sell a put spread (bearish side)
- Profit if stock stays in the middle
Example: Sell 1950 call, buy 2000 call, sell 1850 put, buy 1800 put.
Profit if INFY stays between 1850 and 1950. Much higher probability of profit, but max loss is also larger.
How PipJournal Helps
While PipJournal focuses on forex, options traders need the same discipline. Log every credit spread: entry strikes, credit collected, exit price, actual P&L. Track: ‘What % of my spreads reach 50% profit? How many turn into max losses?’ Over 30+ trades, you’ll see patterns. Some traders win 80% of spreads but lose big when they lose. Others win 65% with small losses. That pattern data drives position sizing and risk management.
