Credit Spread

What Is a Credit Spread?

A credit spread is a two-leg options position in which an investor sells one option and buys another of the same type and expiration but with a different strike price. The option sold is worth more than the option bought, so the trade brings in a net payment, called a credit, when it is opened. The option purchased limits how much the position can lose. The term is also used in bond markets, where it describes the yield gap between a corporate bond and a comparable Treasury bond, reflecting the extra compensation investors demand for credit risk.

How a Credit Spread Works

Two common forms exist. A bull put spread sells a higher-strike put and buys a lower-strike put, and it generally profits if the underlying stock stays above the sold strike. A bear call spread sells a lower-strike call and buys a higher-strike call, and it generally profits if the stock stays below the sold strike. In both cases, the maximum profit is the net credit received, and the maximum loss is the distance between the strikes minus that credit, multiplied by the number of shares each contract covers.

Maximum loss = (Strike difference − Net credit) × 100 per contract

Standard equity option contracts typically cover 100 shares.

Example

Consider a hypothetical trade. An investor sells a put with a strike of 50 for an option premium of 2.00 per share and buys a put with a strike of 45 for 0.80 per share. The net credit is 1.20 per share, or 120 dollars per contract. The strikes are 5 points apart, so the maximum loss is 5 minus 1.20, or 3.80 per share, or 380 dollars per contract. If the stock finishes above 50 at expiration, both options expire worthless and the investor keeps the full 120 dollars.

Why It Matters to Investors

Credit spreads define the maximum gain and maximum loss when the trade is opened, which is one reason they are studied by investors who want losses capped. The trade-off is that the potential profit is limited to the credit received, and early assignment on the short option is possible. In bond markets, a widening credit spread often signals that investors see higher credit risk or want more compensation for holding corporate debt, while a narrowing spread suggests the opposite. Credit spreads are not guarantees of any outcome, and their value can change with market movements, volatility, and the passage of time.