What is a Credit Spread?
A credit spread is the difference between the prices of two different securities involved in a purchase and sale. With credit spreads, the value or price of the option that is purchased will be less than the value of the security that is sold. The end result of the credit spread is the investor makes a small gain in cash balance with the set of transactions. The key to increasing the cash balance in the investor account with a credit spread involves choosing the securities used in the spread option with great care. One common example is to make use a mix of securities that are currently considered to be bullish and bearish in the marketplace. That is, one security is considered aggressive and likely to increase in value while the other is considered to be somewhat stagnant and not anticipated to experience much growth in the near future. By combining a bull spread that uses puts with a bear spread employing calls, it is possible to achieve a nice profit from the sequence of transaction
When you sell a credit spread, you simultaneously sell one option and buy one option for a stock as a single transaction. The options are traded for the same expiration month, with different strike prices and are either both call options or both put options. You sell the more expensive option, and buy the cheaper option, resulting in a credit to your account. Huh? Ok, here is an example: Bear Call Credit Spread Using trend analysis, you have determined that Stock XYZ is trending down (Bearish). It is quite a strong trend, so you feel secure in placing a trade. XYZ is trading at $100 per share, towards the end of May. TRADE: Sell XYZ 120 June Call for 0.80. Credit $80 Buy XYZ 125 June Call for 0.30. Debit (cost) $30 (further OTM, therefore cheaper) Net Credit $50 You sell an OTM Call Option for XYZ for the closest expiration date (not more than one month out), at a strike price of $120. You simultaneously buy (this is done as one transaction) an OTM call option at a further out strike p
It is an option trading strategy. Spreads involve simultaneously (A) selling an option contract while (B) buying another option contract. Both contracts (A and B) represent the same stock, the same time frame, but different prices for the underlying stock or index. Q: How does PowerOptionsApplied use spreads? A: The two spread strategies we use are called credit spreads. The cash you receive for selling one contract is going to be more than the cash you pay to buy the other contract. When you initiate our recommended spread trades, you realize an instant cash income. The instant cash is called a net credit. Q: What are the risks associated with spread trading? A: While a credit spread trade is open, there is some probability that the underlying stock or index will head in an undesirable direction. If the underlying stock or index heads in the wrong direction you can lose your entire investment. However, we provide exit points to limit any potential losses. Also, the combination of two
A credit spread is the simultaneous sale of one call (or put) and the purchase of a call (or put) that is further out of the money (OTM) than the call or put sold and therefore less expensive. There are two types of credit spreads: bear call spreads and bull put spreads. The “spread” is the difference between the two strike prices.
