Multi-leg Strategies
Credit Spread
A credit spread involves buying and selling options of the same type (call or put) with the same expiration date but different strike prices. It’s called a "credit" spread because it results in a net premium credit, or sale proceeds, when you create the strategy. Credit spreads can use call options (bearish) or put options (bullish), depending on the investor’s outlook.
- Outlook: Bearish if using call options; Bullish if using put options
- Use: Primarily used when attempting to profit from small movements in the price of the underlying stock
- Profit: If using call options, you’ll profit if the stock price falls below the breakeven price. If using put options, you’ll profit if the stock price rises above the breakeven price
- Loss: For call options, you’ll incur losses if the price of the underlying asset rises significantly above the strike price of the lower call option. For put options, you’ll incur losses if the price of the underlying asset falls significantly below the strike price of the higher put option
Risks
Credit spreads provide a defined risk-reward profile and provide controlled exposure to underlying price movements. While your maximum loss is capped at the difference in strike prices minus the net premium received, there is still the risk that your short option position may be assigned.
Basic example
Let’s say that you believe there will be either a small downward or no price movement for FlyFit over the coming months. FlyFit is trading at $100 so you sell a call option with a $95 strike price for an $8 premium and you purchase a call option with a $105 strike price for a $3 premium. This debit spread is often called a bear call spread.
- Strike price: $95 Short, $105 LongStrike price represents the amount you’d receive if your short call were to be assigned, or the price you’d pay if you were to exercise your long call
- Contract price: $8 Short, $3 LongPer-share price of the option contracts
- Total sale proceeds: ($8 - $3) x 100 = $500Options have a contract multiplier, or the number of shares presented. The sale proceeds is the premium collected for selling the lower strike call ($8), less the premium paid for buying the higher strike call ($3), multiplied by the contract multiplier. There may be add’l fees charged by your Brokerage
If you get assigned on the short call option, you’d deliver 100 shares and receive $9,500. If you exercise the long call option, you’d purchase 100 shares for $10,500.
Maximum profit and loss
The P/L calculations take into consideration both the short call position and the long call position.
- Max loss: $500Lower strike price (short) - higher strike price (long) + net premium received
- Breakeven: $100The breakeven is equal to the lower strike price + net premium received, or the total premium received - premium paid
- Max profit: $500The maximum profit of a credit spread is the net premium received. In the case of a call credit spread, the amount you received for the lower strike call less amount you paid for the higher strike call
The max profit is capped and can be obtained at a stock price of $95 or lower. Below $95, the profit does not continue increasing.
Profit if...
FlyFit’s stock price is below the breakeven.
- Total profit: ($95 - $98 + $5) x 100 = $200Profit received for the options is the maximum profit assuming the price does not trade in-the-money.
If FlyFit's stock price falls below the $100 breakeven but remains above the lower strike price, you can purchase FlyFit in the open market for $9,800 and deliver them for $9,500, incurring a $300 loss. However, since you’ve already collected a $500 net premium, you end with a $200 profit.
If the price continues declining below $95, both calls become out-of-the-money, and the options expire worthless. Since you’ve already collected a $500 net premium, you end with a $500 profit.
If the price continues declining below $95, both calls become out-of-the-money, and the options expire worthless. Since you’ve already collected a $500 net premium, you end with a $500 profit.
Loss if...
FlyFit’s stock price moves above the breakeven and it costs you more to deliver the stock than you receive in net premiums.
- Total loss: ($95 - $103 + $5) x 100 = $300The maximum of the current price and lower strike price, less the higher strike price, plus the net premium received
In the scenario above, the price of the underlying has risen to $103. As a result, the call option with the lower strike will be assigned and you will have to purchase shares at $10,300 and deliver them for $9,500, resulting in a $800 loss. However, since you already collected a $500 premium, the total loss is reduced to $300.
If the price of FlyFit continues rising above $105, both options become in-the-money. While you can purchase 100 shares at the below market rate of $105, you will likely have to deliver 100 shares for $95. This would result in a loss of $100, or $1,000. However, since since collected a $500 premium, the total loss is reduced to $500.
If the price of FlyFit continues rising above $105, both options become in-the-money. While you can purchase 100 shares at the below market rate of $105, you will likely have to deliver 100 shares for $95. This would result in a loss of $100, or $1,000. However, since since collected a $500 premium, the total loss is reduced to $500.
Brokerage services for US-listed securities and options offered through Public Investing, member FINRA & SIPC. Supporting documentation upon request.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
Options resource center
Options Foundations
Fundamentals
Multi-leg Strategies
Chapter 14Long straddle
Chapter 15Long strangle
Chapter 16Debit spread
Chapter 17Credit spread
Chapter 18Calendar spread