Definition
The term credit spread refers to an options strategy where the premiums received are greater than those paid. Credit spreads result in funds being credited to the investor's account when the position is first established.
Explanation
When the premium received from the short leg of a spread is greater than that paid for the long leg, the position is referred to as a credit spread and results in funds being deposited into the trader's account. Credit spreads are a low risk, low reward strategy. The net credit received when the position is established is the maximum profit achievable.
Credit spreads typically take one of the following forms:
Bull Put Spreads: if the trader is bullish on the underlying security, they can establish a bull put spread by selling a higher premium in-the-money put option and buying a lower premium out-of-the-money put option on the same underlying security and the same expiration date.
Bear Call Spread: if the trader is bearish on the underlying security, they can establish a bear call spread by selling a higher premium in-the-money call option and buying a lower premium out-of-the-money call option on the same underlying security and the same expiration date.
Related Terms
The term delta refers to the rate of change in the theoretical premium paid or received for an option for one unit change in the price of the underlying asset. Delta values for call options will always be positive, while those for a put will always be negative.
Moneyzine EditorJanuary 15th, 2024
The term delivery refers to the process of fulfilling the terms of an options contract following the notification of assignment. While delivery can apply to options and forward contracts, a position is oftentimes closed out prior to the expiration date to avoid delivery.Moneyzine EditorJanuary 15th, 2024- The term time decay refers to the theoretical decline in the value of an option over time. Time decay directly affects the extrinsic value of an option.Moneyzine EditorSeptember 21st, 2023
The term debit spread refers to an options strategy where the premiums received are less than those paid. Debit spreads result in funds being debited to the investor's account when the position first is established.Moneyzine EditorJanuary 15th, 2024
