Credit spreads are the workhorse of options income trading. They offer defined risk, capital efficiency, and high-probability setups that can generate consistent monthly returns. If you have a smaller account or want to limit your risk exposure, credit spreads should be your go-to strategy.
What is a Credit Spread?
A credit spread involves selling one option and buying another option at a different strike price. You receive a net credit upfront, and your maximum risk is limited to the width of the spread minus the credit received.
The key advantage: Your maximum loss is known before you enter the trade. Unlike naked options where losses can be theoretically unlimited, credit spreads cap your risk to a predetermined amount.
Put Credit Spreads (Bull Put Spread)
Use when you are bullish or neutral on a stock. You profit if the stock stays above your short strike.
Put Credit Spread Example
AAPL at $180, you are bullish
- Sell $175 put for $3.00 (short strike)
- Buy $170 put for $1.50 (long strike - protection)
- Net credit: $1.50 ($150 per contract)
- Spread width: $5 ($500)
- Max risk: $5 - $1.50 = $3.50 ($350)
- Max profit: $1.50 ($150) if AAPL stays above $175
- Return on risk: 42.8%
- Breakeven: $173.50 ($175 - $1.50 credit)
Call Credit Spreads (Bear Call Spread)
Use when you are bearish or neutral. You profit if the stock stays below your short strike.
Call Credit Spread Example
TSLA at $250, you are bearish
- Sell $260 call for $5.00 (short strike)
- Buy $270 call for $2.50 (long strike - protection)
- Net credit: $2.50 ($250 per contract)
- Spread width: $10 ($1,000)
- Max risk: $10 - $2.50 = $7.50 ($750)
- Max profit: $2.50 ($250) if TSLA stays below $260
- Return on risk: 33.3%
- Breakeven: $262.50 ($260 + $2.50 credit)
Selecting Strike Prices
Strike selection determines your probability of profit and potential return.
By Delta
- 0.30 delta short strike: ~70% probability of profit. Lower premium but safer.
- 0.20 delta short strike: ~80% probability of profit. Even lower premium, higher win rate.
- 0.40 delta short strike: ~60% probability of profit. Higher premium, more risk.
By Distance OTM
- 5% OTM: Moderate premium, balanced risk/reward
- 10% OTM: Lower premium, high probability
- At technical support/resistance: Use charts to find logical strike levels
Strike Selection Rule
For consistent income, sell the short strike at 0.25-0.30 delta (70-75% probability of profit). This balances premium collection with win rate.
Optimal Spread Width
The width between your strikes affects risk and return.
Spread Width Comparison
SPY at $500, selling 0.25 delta put spreads
| Width | Credit | Max Risk | Return |
|---|---|---|---|
| $2 wide | $0.50 | $150 | 33% |
| $5 wide | $1.25 | $375 | 33% |
| $10 wide | $2.40 | $760 | 32% |
**Key insight:** Wider spreads collect more absolute premium but similar percentage returns. Narrower spreads let you take more positions for diversification.
Expiration Selection
Time to expiration affects theta decay and premium.
- 30-45 DTE: Sweet spot for theta decay. Most income traders use this range.
- Weekly (5-7 DTE): Faster decay but higher gamma risk. More management needed.
- 60+ DTE: More premium but slower decay. Capital tied up longer.
Managing Credit Spreads
Taking Profits Early
Do not wait until expiration. Close winning trades early to free up capital.
- 50% profit: Close the trade. You captured half the premium in usually half the time.
- 75% profit: Definitely close. Remaining $0.25-0.50 is not worth the risk.
- 21 DTE rule: Consider closing all spreads with less than 21 days left regardless of profit.
Early Close Example
Sold put spread for $1.50 credit, 45 DTE
- Day 15: Spread worth $0.70 (53% profit)
- Action: Buy to close for $0.70
- Profit captured: $0.80 in 15 days
- Annualized return: 65% vs waiting for full $1.50
Managing Losers
- Close at 2x credit: If you received $1.50, close if spread reaches $3.00
- Roll when tested: If price approaches short strike, roll down/out for credit
- Never hold to max loss: Cut losses early to preserve capital
Rolling Spreads
Rolling a Tested Spread
Original: Sold $490/$485 put spread on SPY for $1.50. SPY drops to $492.
- Current spread value: $2.80
- Buy to close $490/$485 spread for $2.80
- Sell new $480/$475 spread expiring 30 days later for $1.80
- Net debit: $1.00
- Total credit in trade: $1.50 - $1.00 = $0.50
- New breakeven lowered from $488.50 to $479.50
Income Calculations
Here is what consistent credit spread trading can generate:
Monthly Credit Spread Income
$25,000 Account Trading Credit Spreads
- Risk per trade: $500 (2% of account)
- Trades per month: 4-6
- Average credit: $125 (25% of risk)
- Win rate: 75%
- Monthly expectancy: (0.75 x $125 x 5) - (0.25 x $375 x 5) = $468.75 - $468.75 = $0
Wait, that is breakeven? Yes, if you hold to expiration. The key is closing winners at 50% profit:
- Average win: $62.50 (50% of max)
- Average loss: $250 (at 2x credit stop)
- Monthly expectancy: (0.75 x $62.50 x 5) - (0.25 x $250 x 5) = $234.38 - $312.50 = -$78
Still not great? Increase win rate to 80% with proper strike selection:
- Monthly expectancy: (0.80 x $62.50 x 5) - (0.20 x $250 x 5) = $250 - $250 = $0
The real edge: Comes from position management, rolling, and avoiding max losses. Skilled traders generate 2-4% monthly ($500-$1,000 on $25K).
Best Underlyings for Credit Spreads
- Index ETFs: SPY, QQQ, IWM - Liquid, diversified, no earnings
- Large cap stocks: AAPL, MSFT, GOOGL - Liquid options, predictable
- High IV stocks: AMD, TSLA, NVDA - Better premiums (but more risk)
Credit Spread Mistakes to Avoid
- Selling too close to ATM: Chasing premium increases loss frequency
- Ignoring earnings: Close or avoid spreads before announcements
- Oversizing: Multiple spreads in same direction = concentrated risk
- Holding to expiration: Pin risk can cause unexpected losses
- No stop loss: Small losses become big losses without rules
Track Your Credit Spread Performance
Pro Trader Dashboard automatically calculates your credit spread win rate, average profit, and total income. See which strategies and underlyings work best for you.
Summary
Credit spreads are the foundation of options income trading. They offer defined risk, capital efficiency, and consistent income potential when traded properly. Focus on proper strike selection (0.25-0.30 delta), take profits at 50%, and manage losers before they become max losses.
With discipline and proper management, credit spreads can generate 15-30% annual returns with controlled risk.
Ready for more advanced strategies? Learn about iron condors which combine put and call credit spreads, or explore other premium selling strategies.