Ever wondered how traders make steady profits without risking it all? Credit spreads might be the answer you’ve been looking for.
This beginner-friendly guide breaks down the strategy step by step to help you trade smarter, limit your losses, and grow your confidence in the market.
You won’t find fluff here. After reading this article, you’ll understand credit spreads and how to smartly use them, even if you’ve never placed an options trade before. So, let’s dive in!
What Are Credit Spreads?
Credit spreads in options trading are strategies where you collect money upfront by selling one option and buying another option of the same type with different strike prices.
Here Credit means you receive cash when you open the trade. It happens due to the option you sell is worth more than the option you buy.
There are two main kinds of credit spreads:
- Bull Put Spread: You sell a put option at a higher strike price, then buy a put option at a lower strike price. If the stock stays above the strike price you sold, you’ll make money.
- Bear Call Spread: Here, you sell a call option at a lower strike price. Then, you buy a call option at a higher strike price. Earning starts if the stock stays below the strike price you sold.
The main difference between these strategies is how you see the market.
Both strategies come with clear risks and rewards. If you’re new to options trading, these will let you earn while keeping your losses small.
Why Credit Spreads? Benefits & Drawbacks
Credit spreads offer a balanced approach to options trading. They’re designed for traders who want steady profits without the wild swings of buying options outright.
Benefits
- You get paid upfront when you open the trade.
- Your risk is clear from the beginning, exactly how much you could lose.
- Time is in your favor, the sold option fades faster which boosts your profit.
- You don’t need a big market move to win.
- It works in many market types.
Drawbacks
- You can’t earn more than the credit you received.
- If the stock goes past your sold strike, you might get assigned early.
- Transaction costs can eat into profits.
- Big moves in either direction can flip your trade and can turn you a loser quickly.
Read More: Covered Calls Vs Credit Spreads
6 Step-by-Step Guide to Implementing a Credit Spread Strategy
Credit spreads are powerful when used the right way. This step-by-step guide will walk you through how to trade them smartly, one move at a time.
Step 1: Market Outlook
Before anything else, pause and ask yourself: Where do you think the market is headed?
If you’re feeling bullish, meaning you expect prices to go up, a bull put spread is your go-to. If you’re leaning bearish, expecting a drop, a bear call spread fits the bill.
And if you think things will stay flat for a while, either strategy can work. Just choose the one with the better premium.
Step 2: Choose Underlying & Expiration
Pick stocks or ETFs that trade a lot and have a liquid options market. SPY, QQQ, Apple, or Microsoft are active and reliable.
Next, choose an expiration date about 30 to 45 days out. It gives the trade room to breathe, but not too much time that the premium thins out.
Tip: steer clear of earnings dates or major economic news. They bring surprises, and surprises aren’t your friend here.
Step 3: Select Strikes (Based on Probability)
This step is the heart of the trade. Now it’s time to pick your strike prices. Aim for options with a 70–80% chance of success. That’s your sweet spot.
- For bull put spreads, sell a put that’s 10–15% below the current price.
- For bear call spreads, sell a call that’s 10–15% above the current price.
Keep the two strike prices about 5 to 10 points apart. It’ll strike a nice balance between risk and reward.
Step 4: Execute the Two-leg Order
Place both legs of the trade at the same time, as a single order.
- For a bull put spread, sell the higher strike put, then buy the lower strike to protect yourself.
- For a bear call spread, sell the lower strike call, then buy the higher strike as your shield.
Use a limit order so you stay in control of your entry price. No one likes surprises at the checkout.
Step 5: Monitor; Close Early or Let Expire
This isn’t a set-it-and-forget-it trade. Check-in every day.
Once you’ve made 25–50% of your max profit, it’s smart to consider closing the trade early. No need to squeeze every last drop. Keep your eye on the stock price, volatility, and days left until expiration.
If the price gets too close, or past your short strike, that’s your cue to act. Decide if you’ll close it out or ride it to the finish line.
Step 6: Rolling and Adjustments
Sometimes the market moves against you. It happens.
When it does, you can roll the spread, push it out to a later expiration while keeping your strikes similar. You can also adjust the other side of the trade to collect more premium.
And if it’s just not working? Don’t wait. Close it before expiration to keep the losses in check.
Risk and Trade Management
Let’s start with the golden rule: never risk too much on one trade. Keep it to 1–2% of your total account. That way, even if a trade goes south, it won’t sink your whole ship.
Before jumping into any trade, decide where you’ll get out. Set your profit and loss targets ahead of time. A smart move is to take profits when you’re up 25–50% of the max potential.
On the flip side, set a stop-loss at around 200–300% of the premium you brought in. That’s your parachute if things fall apart.
Timing matters, too. Stay clear of the earnings reports, fed announcements, or big economic news. These shake the market like a snow globe, and credit spreads don’t like surprises.
Spread out your trades. Mix different stocks, sectors, and expiration dates. Don’t put all your eggs in one basket. And always keep good records. You’ll be surprised how much you learn from your history.
Lastly, don’t wait until the last minute. Close trades when there’s about a week or so left, 7 to 10 days is a safe window. It avoids last-minute panic and protects your capital from unexpected assignments.
6 Common Trade Mistakes and How to Avoid Them
Trading feels exciting. It gives you a rush.
But one wrong click, and your screen is filled with red. You sit there wondering, “What just happened?”
Let’s walk through the common mistakes that often go unnoticed but slowly eat away at your profits. Here’s how to avoid them.
1. Cutting It Too Close to Expiration
Trading too close to the finish line is a risky game. The closer you get to expiration, the higher the chance of assignment, and the smaller your profit window becomes.
Fix: Open trades with at least 21 days till expiration. And close them out with 7–10 days left, even if they’re doing fine.
2. Going Too Big, Too Fast
It’s tempting to throw a big chunk of your portfolio into a trade that “feels right.” But oversized trades can wipe you out fast.
Fix: Never risk more than 2% of your total account on a single trade. Know your max loss before you jump in, and make sure it’s a loss you can live with.
3. Chasing Fat Premiums
Sure, big premiums look good. But high reward usually means low odds.
Fix: Target for trades with a 70–80% chance of success. Even if the payout seems small, consistency wins in the long run.
4. Ignoring Earnings Dates
One earnings surprise can turn a winning trade into a disaster.
Fix: Always check the earnings calendar. If a company’s reporting while you’re holding the trade, skip it. There’ll be other chances.
5. Holding on for Too Long
Waiting until expiration for max profit sounds good, until it isn’t.
Fix: Take your profits early, around 25% to 50% of the total possible gain. It reduces risk and lets you trade more often.
6. Freezing on Losing Trades
Hope is not a strategy. And letting a bad trade linger only digs the hole deeper.
Fix: Set a stop-loss around 2 to 3 times the premium you collected. And stick to it, without second-guessing.
Final Verdict
Credit spreads aren’t about striking it rich overnight. They’re a steady way to trade, protecting your downside while giving you room to grow your profits.
Sure, it takes patience, and maybe a little grit, but if you play it smart and stay consistent, credit spreads can become your trading’s quiet powerhouse.
Start with a small step. Keep your focus sharp. Then watch how steady moves turn into real results.