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Credit Spread Options Strategies Explained (Guide w/ Examples)

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Get one projectoption course for FREE when you open and fund your first tastyworks brokerage account with more than $2,000: https://www.projectoption.com/free-options-trading-course/ Learn More About tastyworks: https://www.projectoption.com/tastyworks/ OPEN a tastyworks Account: https://start.tastyworks.com/#/login?referralCode=PROJECTOPTION ============ The two credit spread options trading strategies are very simple to understand and set up, but also extremely powerful. Credit spreads are very popular options strategies among income-driven traders, as they have a high probability of profit, have limited loss potential, and are easy to manage. In this video, we'll clearly explain what a credit spread is, how they are set up, and go through examples to show how they profit. Credit spreads can be constructed with all call options or put options. When constructed with all calls, the strategy is a call credit spread (sometimes called a 'bear' call spread since it's a bearish strategy). When constructed with all puts, the strategy is a put credit spread (sometimes called a 'bull put spread' since it's a bullish strategy). In this video, we cover two examples using historical option data to show you exactly how these two strategies make money and lose money. Lastly, we'll show you how to set up each strategy using the tastyworks trading platform. ==== RESOURCES ==== Trade with tastyworks (& Get a Free Course): https://www.projectoption.com/tastyworks/ Our Options Trading Courses: https://www.projectoption.com/options-trading-courses/ ==== FAVORITE OPTIONS TRADING BOOKS ==== How to Price & Trade Options: https://amzn.to/2FqsPmn Option Volatility and Pricing: https://amzn.to/2SU6f8K
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Text Comments (43)
projectoption (6 months ago)
Close Trades for Free.* $10 Max Commission Per Option Leg.** https://www.projectoption.com/tastyworks/
ChronicStreak (20 days ago)
Great explanation, thanks
Arathae Maxus (1 month ago)
So, if you lose on this strategy, you end up owning stock because of the put you sold? Which means you can recover losses when the stock price goes up correct? Or if you’re in a losing position, you could exercise the put you bought on the last day by buying stock at the current price, sell the stock for profit using your put, buy stock from the put you sold, wait for the price to go up, sell the extra stock to recover. Did I get this right?
projectoption (29 days ago)
If you sell a put spread, you do not want the stock price to decrease significantly, even though that would lead to a big increase in your long put option. However, since your short put option is at a higher strike price, the short put will be worth more than the long put, resulting in a net loss. You could potentially sell the long put on a stock price decrease and hope that the stock price increases later on, resulting in profits on your short put. I would not recommend this approach as selling the long put would increase your risk dramatically and may not work out as intended.
projectoption (29 days ago)
Getting assigned on a short option depends entirely on the amount of extrinsic value that exists in the option. If the stock price is only slightly below your put's strike price, it's likely the put option has lots of extrinsic value. For example, if the stock price is $89 and the $90 put is trading for $5, $1 of that is intrinsic and $4 of that is extrinsic. If somebody exercised that put option, they'd be flushing $400 down the toilet because an option buyer loses all the extrinsic value in the option when they exercise the option. If you are assigned on a short put, you'll end up with +100 shares per put you were assigned on. There are two ways to get assigned: the option buyer exercises the option and you are assigned OR you hold the short put option through expiration while the stock price is below the put's strike price. Your profit when selling a put option is the difference between the sale price and the final value of the option. If you sell a 75-strike put option for $4.00 and the stock price is at $74 at expiration, the put option will be worth $1.00 and you'll be assigned 100 shares. Your profit per put option would be $300 ($4.00 sale price - $1.00 final/expiration value) x 100 = $300. Then, you could hold onto those shares you got assigned and hopefully sell them back later at a higher price.
Arathae Maxus (1 month ago)
I’m just wondering if the put you bought could be used in some way to benefit rather than letting it expire. Or would the price need to drop severely for this to work?
Arathae Maxus (1 month ago)
Ok so if I sell a put and the price drops. Is it still unlikely the buyer will exercise the put and assign me the shares? If not, I keep the money made from selling the put correct? If so then I’m assigned shares at the strike price? But on paper I can minus the money made from selling the put thus the actual price I paid could be considered a bit less. I then keep the shares until the price increases then sell those shares for profit?
projectoption (1 month ago)
You will only end up with long stock if you sell a put spread and ONLY the short put option is in-the-money when the options expire. If both the short put and long put are in-the-money and you hold the options through expiration, the short put assignment (+100 shares) and long put exercise (-100 shares) will offset and you'll end up with no shares. You'll still get charged exercise/assignment fees, however. Regarding the second scenario, you can't choose to buy shares of stock at the strike price of the put you've sold. The only time you have control of converting an option into shares of stock is if you own the option. Option buyers have the right to exercise while option sellers have the obligation to take the other side of that transaction IF the option is exercised and the option seller is assigned. Lastly, there aren't any quick profits to be made by purchasing shares at the current stock price and exercising your put to sell the shares. The reason for that is the put option you're exercising will be equal to or more than the value of that particular transaction, negating any risk-free profits. For example, if you own the 90 put option and the stock price is at $80, the 90 put will be worth at least $10 (the put's "intrinsic" value), which is the difference between the strike price and the stock price. In reality, the 90 put would likely be worth more than $10, and any of that additional (extrinsic) value will be lost when you exercise the put. Let's say the stock price is at $80 and the 90 put is worth $12. If you buy 100 shares at $80 and exercise your put option, you'd actually lose $200 because you sold your shares at $90 for a $10 gain on the shares ($1,000 gain on 100 shares), but you just lost your $12 put option ($1,200 in value) by exercising it and selling your shares. Personally, I think it may be helpful to approach options trading from the idea that traders buy/sell options in anticipation of profiting from the price changes in the options, not from converting the options into shares and making additional trades from there. I've been trading options actively for over 6 years now and I've only been assigned on short options maybe 2-3 times and exercised options fewer times than that. I know this may be very confusing so please feel free to reply with follow-up questions. I'm always happy to help those eager to learn! -Chris
chevy8758 (3 months ago)
Dude, Thank you for having a video that actually explains what you're doing
projectoption (3 months ago)
You're welcome! I'm glad you liked the video! -Chris
Danny Tan (3 months ago)
One of the best explanations I've seen. I'm a big fan of tastyworks but unfortunately they are not 'regulated' by the Monetary Authority of Singapore, yet. It'd be nice if you could show a version using the Thinkorswim platform (which is regulated in Singapore). Thanks.
Alex Nguyen (5 months ago)
Hey so i'm confused on when to close out. Do you have to wait until the expiration date and just let it time out or do u close it when ever u have profit?
Jim Fincannon (4 months ago)
Thank you, I was wondering the same thing.
projectoption (5 months ago)
Hi Alex, You can close an option position whenever you want. The expiration doesn't change the trading 'rules' of the contract, it just means after that expiration date the option will no longer exist. Here's a video I just did that talks about this topic: https://youtu.be/IG3tJrJYd2U I hope this helps! -Chris
TB (5 months ago)
So you risk 3 to make 1.... stupid. Might as well go to Vegas
Seth Jay (5 months ago)
why and when would you set up a spread when one strike is above and below te stock price? You are putting them both below?
projectoption (5 months ago)
Hi Seth, When trading credit spreads (selling call spreads or selling put spreads), it's common to place both strikes "out-of-the-money." For call spreads, that means both strikes of the spread are above the stock price. For put spreads, that means both strikes of the spread are below the stock price. The only time I trade spreads with one strike in-the-money and one strike out-of-the-money is if I'm buying a call spread or put spread (sometimes referred to as debit spreads). Does this help? Please let me know if you need more clarification. Happy to help. -Chris
Seth Jay (5 months ago)
Excellent teacher but use alot of useless jargon
projectoption (5 months ago)
Thanks for the comment/feedback, Seth! I'll try my best to not use as much jargon in the future.
Sean Reilly (5 months ago)
Project Option: Thank you for the video. In the last example where you're discussing selling a bear credit spread for $1.90 net credit, what happens if TSLA stock price is at $316.00 at expiration? I would assume then that the 320 call that was purchased would expire worthless, and the 315 call that was sold would expire ITM. At this point, wouldn't the seller of this spread be assigned 100 shares of TSLA stock at $315 dollars? In this case, would you need $31,500 to purchase the shares or risk getting margin called by your broker? My concern here is the following: As long as one sells credit spreads and CLOSES the position (i.e. buys back the call that was sold initially, and sells the call that was purchased initially) PRIOR to the expiration date on the contracts, can one avoid assignment 100% of the time? I know that one can is at risk of "early assignment" when selling calls, which would cause problems with this strategy, and also means that in this case one would need $31,500 before selling this spread? Thank you again for the insight and I am looking forward to starting to sell credit spreads once I have this point cleared up.
projectoption (5 months ago)
Sean, You're exactly right. If a trader sells the 315/320 call spread and TSLA is at $316 at expiration, the 320 call expires worthless and the 315 call is worth $1. If held through expiration, the trader would get assigned on the short 315 calls, and effectively short 100 shares of TSLA stock at $315/share (per short call contract). Yes, you would have margin issues if your account was not large enough to handle the margin requirement. In that scenario, you'd have to close the position immediately, otherwise, your brokerage firm will close it for you. You would not need $31,500 to sell this spread, and the risk of getting assigned early is very low. The most common scenario is if the short call is deep-in-the-money with very little extrinsic value and the stock was paying a dividend soon. Since TSLA does not pay dividends, early assignment should be very rare. Again, extrinsic value is the key metric to look at on your short in-the-money options. Lots of extrinsic value = virtually no risk of being assigned. Almost no extrinsic value = higher likelihood of assignment, but still low.
Devin Nguyen (6 months ago)
I am hoping this finds you. I am in need of guidance on a successful option. I don’t know if I should continue to hold or sell. My current AMD option Put Debit spread is $25-18. How do I know when I am capped on earnings and should sell early??? Do I sell when my bottom range $18 breaks even at $16.95??? It’s very near that now and I am panicking. Please please advice.
carl lefler (1 month ago)
like
Devin Nguyen (6 months ago)
projectoption you can disregard. I sold out of the position. Made $500.
projectoption (6 months ago)
Hi Devin, Can you clarify what position you have on? Which option have you purchased? Which option have you sold? What price did you pay/receive for the entire spread?
thomas o muldoon (6 months ago)
great! a vid that actually shows how to put on a spread that makes money, not just all the gadgets that ALLOW you to sink or swim!
projectoption (6 months ago)
Thanks for the comment, Thomas!
Intsik Beho (7 months ago)
in depth but great explanation.
projectoption (7 months ago)
Thank you! Glad you liked it.
Jose Garcia (7 months ago)
I think this strategy is great...you know the risk off top and you collect the premium when it expires worthless or maybe taking a little profit along the way.................I like it....selling puts is a no brainer.
- - (4 months ago)
how is it great, if a loss is 3x bigger than profit??
rstallings69 (9 months ago)
What I don’t get is doesn’t the short put aspect still have value at the end since trading at 324$-? Anyone can answer,, and am I right in thinking that no one would assign you except by accident cause you would end up buying shares at 315 and could then turned around and sell for 324- but could be issue if you don’t have 31,500$?
projectoption (9 months ago)
Thank you!
rstallings69 (9 months ago)
great vids!
rstallings69 (9 months ago)
projectoption thanks a lot!
projectoption (9 months ago)
With the stock trading at $324 at expiration, the 315 put has no value because put options give the buyer the right to sell 100 shares at the strike price. When the stock price is above the put strike, there's no value in the ability to sell shares at a lower price than the shares are currently trading. In this case, the put trader has two choices if they want to sell/short shares of stock: they can sell/short shares at the current market price of $324/share, or exercise the put option and sell/short shares at $315/share. Of course, selling/shorting shares at $324 is more advantageous than selling/shorting shares at $315 per share, which is why the 315 puts are worthless at expiration--nobody would willingly sell shares at $315 when they can sell them for $324. Since nobody would exercise a 315 put with the stock at $324, there's a 0% chance of being assigned on the 315 short puts when the stock price is at any price above the put's strike price of $315. In regards to getting assigned, a trader would have margin issues if they were assigned on the 315 short put and did not have enough money to actually hold the position. Normal stock margin is 50%, which means the margin requirement is 50% of the notional value of shares. In the case of 100 shares at $315/share, that's $31,500 in notional value. 50% of $31,500 is $15,750. If the trader was assigned on the short 315 put and did not have $16,000+, they would have to close the stock position (or the brokerage will do it for them). I hope this helps! -Chris
jemibanez (10 months ago)
How about relative implied volatility aspects (when choosing this strategy)?
jemibanez (10 months ago)
That's right yes..:)
projectoption (10 months ago)
Do you mean distinguishing between 'high' and 'low' implied volatility levels before entering?
GapBahnDirk (11 months ago)
A great explanation of credit spreads and TW. Thanks Chris! (Greg H)
projectoption (11 months ago)
Thanks so much for the comment! Glad you liked it! Any suggestions for future topics?
Wedgewood Pinseekerston (11 months ago)
Great vid, easily understood.
projectoption (11 months ago)
Thank you!

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