In finance, If there is an involvement of a purchase of one option and a sale of another option in the same class and expiration but different strike prices then it is referred to as a credit spread, or net credit spread. For entering the position investors receive a net credit, and they want the spreads to narrow or expire for profit. On the contrary, to enter a debit spread an investor would have to pay.
Credit Spread Options
A credit spread is used by a trader as a conservative strategy which is designed to earn modest income for the trader while also having losses strictly limited. Simultaneously buying and selling of (writing) options on the same security/index in the same month, but at different strike prices are involved in it. (This is also a vertical spread)
If the trader is BEARISH (expects prices to fall), then you have to use a bearish call spread. This name is given to it due to the reason that you’re buying and selling a call and taking a bearish position.
Let us consider the following.
Trader James expects XYZ to fall from its current price of $35 a share.
Write 10 January 36 calls at 1.10 $1100
Buy 10 January 37 calls at .75 ($ 750)
net credit $350
Now you should consider the following scenarios:
There is a fall in the stock or it remains below $36 by expiration. In this case all the options expire worthless and the trader has got the net credit of $350 minus commissions (probably about $20 on this transaction) netting approx profit of $330.
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