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Vertical Credit Spread

Lesson 2 of 5
Duration 3:10
Level Beginner
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The credit spread involves two option legs, but results in an investor getting paid a premium to take on a limited amount of risk.

Study Notes:

Let’s assume that you believe shares in Apple (Symbol: AAPL) might decline from the current share price of $160 over the next 30-days. And even if they did move up, it would only be a little higher. In this lesson we’ll discuss how an investor could potentially make money using options from this view.

A 30-day call option at the 170 strike is priced at 3.25. And the 180 strike call option is priced at 1.00. The investor might sell the lower 170 strike and receive $325, and pay $100 to purchase the 180 strike.

Why spend the $100 to buy the 180 call if we believe that the stock going over even 170 is very unlikely?

Because it limits your exposure from potentially infinite losses, no matter how unlikely they seem.

Since the investor is receiving more for the lower strike call than they are paying for the higher strike, the net cost of combining the two strike prices is a credit of $225. The combination in this order is called a vertical credit spread.

Because the investor does not believe the share price will go much higher, they are taking advantage of the difference in premiums on both call options since they expect them to be worthless at expiration. If, as the investor expects, the share price of AAPL falls, they keep the entire premium from the vertical credit spread. In fact, so long as shares in AAPL remain below 170 at expiration, the investor keeps the whole $225.

The initial credit received on the trade raises the breakeven point on the transaction by the amount of the 2.25 credit. Add that to the lower strike price of 170 to calculate a breakeven price of $172.25.

The investor will face rising losses penny-for-penny above this point in the event the share price continues to rise. The distance between the higher and lower strike prices is $10, and since each option contract represents 100 shares, that’s worth $1,000.

Since the investor received $225 to make the trade, the maximum loss the investor could face is $775 and would occur at the upper strike price. The long call at the higher 180 strike price will equally and exactly offset losses from the lower 170 strike no matter how high the stock price goes.

The vertical credit spread is a commonly used strategy with option traders who expect prices to stall or even fall over the lifetime of the option contract.

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10 thoughts on “Vertical Credit Spread”

  • Daphne

    Hi, great lesson! Perhaps you can make a similar lesson on debit spreads. Or is there a specific reason for why only touch upon the topic of a vertical credit spread in the beginners lessons?

  • Juan

    Hello, if I open a position in IBKR mobile as a bull put spread, and I see the market starts moving against my position, can I close only the short leg (instead of the whole position) if I believe the price will continue dropping, so I kill the highest exposure, but leave the opportunity for the long put to produce larger gains before expiry? I understand that by doing this I risk incurring bigger losses if the price does eventually not cross the put strike and it expires worthless
    Thx!

    • Interactive Brokers

      Hello Juan, thank you for reaching out. Please note that IBKR does not provide investment advice.

  • Anonymous

    Hi, thanks for this study note. On TWS, setting a bull put spread (sell a put, buy a put at a lower strike) in the strategy builder is considered as a buy, and more over it is very disturbing to notice the credit value highligted in green is considered a negative value ! I have then three questions about this :
    – is the CPS strategy a real buy or a real sell ?
    – when negotiating the “negative” premium in order to increase it, before transmitting the CPS, is it better to increase or to decrease the “negative” premium value ?
    – and when it comes to exit the CPS, do we execute a buy or a sell order ?
    Thanks a lot for yours answers.

    • Interactive Brokers

      Hello, thank you for reaching out and we apologize for the delayed response.
      It is showing as a negative value because the credit is going to the trader but that is why we mark it clearly with a green “c” in the Order Confirmation Window for how the same spread price displays can differ depending how it’s entered.

      If you sell a CPS or Bull Put Spread the buyer will receive a credit and the seller will pay a premium.
      If you buy a Bear Put Spread (which is the same as selling a Bull Put Spread) the buyer will pay a premium and the seller will receive a premium.

      Regardless of whether you use a combination selector in Order Entry compared to selling the Bear Put and receiving a credit, TWS will price the orders according to how they are classified.

      We hope this helps.

  • Cai Jinyu

    Hi, Why do options prices have positive and negative values? When is it positive or negative for buying and selling options?

    • Interactive Brokers

      Thank you for your question, Cai. Some option prices/strategies are negative because the credit is going to the trader. We mark it clearly with a green “c” in the Order Confirmation Window for how the same spread price displays can differ depending how it’s entered. We hope this information is helpful!

  • Anonymous

    Hi, I want to know how to put a stop loss order on a credit spread or any spread. Last night I had a bull put spread on the QQQ’s and the market dropped through the spread. So I am now in debit quite a lot. How do I add a stop loss order both when writing the spread and maybe later if I have not added the stop loss order. Thanks

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Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

Disclosure: Options Trading

Options involve risk and are not suitable for all investors. Multiple leg strategies, including spreads, will incur multiple commission charges. For more information read the "Characteristics and Risks of Standardized Options" also known as the options disclosure document (ODD) or visit ibkr.com/occ

Disclosure: Multiple Leg Strategies

Multiple leg strategies, including spreads and straddles, will incur multiple commission charges.

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