Credit Spread Trading Explained: Profiting with Defined Risk

📈 Credit Spread Trading Explained: Profiting with Defined Risk

Credit spreads are one of the most efficient strategies for small account traders. Whether you're slightly bullish or mildly bearish, credit spreads let you define your risk, earn passive premium, and benefit from time decay.

💡 What Is a Credit Spread?

A credit spread involves two options of the same type (calls or puts), same expiration, but different strikes:

• You sell one option (closer to the money, collecting premium)
• You buy another option (further OTM, paying less premium)
• The net result: you receive a credit upfront

You benefit when both options expire worthless — you keep the full credit.

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📊 Example 1: Bear Call Spread (Neutral to Bearish)

• Underlying: INTC @ $20.69
• Sell: 21.0 Call @ $0.12
• Buy: 21.5 Call @ $0.04

Net Credit: $0.08 | Max Risk: $0.42 | Breakeven: $21.08

Max Profit: $8 per contract | Max Loss: $42 per contract

Trade logic: You’re betting INTC stays below $21 by expiration. If so, both calls expire worthless and you keep the $8.

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📈 Example 2: Bull Put Spread (Neutral to Bullish)

• Underlying: INTC @ $20.69
• Sell: 20.5 Put @ $0.265
• Buy: 20.0 Put @ $0.14

Net Credit: $0.125 | Max Risk: $0.375 | Breakeven: $20.375

Max Profit: $12.50 per contract | Max Loss: $37.50 per contract

Trade logic: You’re betting INTC stays above $20.50 by expiration. If it does, both puts expire worthless and you keep the premium.

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📐 When Do You Benefit from Credit Spreads?

• Time Decay (Theta): Works in your favor as time passes
• Volatility Drop (Vega): You gain when implied volatility falls
• Range-Bound or Moderately Directional Market: You win without needing a big move

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📌 Quick Reference Table

Strategy	Outlook	Breakeven	Max Profit	Max Loss
Bear Call Spread	Bearish / Neutral	Strike 1 + Credit	Credit Received	Strike Width − Credit
Bull Put Spread	Bullish / Neutral	Strike 1 − Credit	Credit Received	Strike Width − Credit

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💥 High-Reward Example (15 Contracts)

INTC 22/22.5 Bear Call Spread – 15 contracts:

• Net Credit: $0.45 → $675 total
• Max Loss: $0.05 → $75 total
• Breakeven: $22.45
• PoP: ~57.6%

Why it's attractive: You risk $75 to make $675. Strong liquidity, defined risk, and theta/vega in your favor.

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📈 Final Thoughts

• Pick strike prices that align with your probability targets (e.g., 10-delta = ~90% OTM)
• Use credit spreads to define risk and avoid overexposure
• Let time decay and your edge do the work — not luck or hope

Key takeaway: Credit spreads offer a powerful way to profit in uncertain or sideways markets while keeping risk capped and controlled.

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Blog by Deno Trader • Visit: denotrading.com