What Is A Credit Spread Option?



This is a trade that's mentioned within the vocabulary as a vertical spread. The trade is initiated by selling an option closest to the This is a trade that's mentioned within the vocabulary as a vertical spread. The trade is initiated by selling an option closest to the At-The-Money (ATM) strike price and buying one that's further away. The thought of the spread is to gather a credit, and if we have predicted the worth correctly it all expire worthless.





In the financial world, a credit spread option (also known as a ''credit spread'') is a contract option that includes buying one option and selling another option with a different strike price. Effectively this strategy transfers credit risk one party to another by exchanging two options of the same class and expiration.





There's a possibility in this case that the individual credit will increase, allowing the spread to expand, which then reduces the credit price. Spreads and rates go the reverse. When a given credit spread varies from its current amount, the buyer must pay an initial premium in return for future cash flows.





Example





David buys 10 call contracts for $0.50 on a technology stock at a $70 strike price, and sells 10 call contracts on the same stock for $2 at a $65 strike price. His net transaction credit is $1.50 and the credit spread option is executed for a net credit of contracts x 100 shares x $1.50 = $1500.

If the stock price roses at $80, David will exercise his 10 call contracts at a strike price of $70 to acquire 10 contracts x 100 shares = 1,000 shares for a cost of $70,000. He's expected to sell his 10 call contracts at a strike price of $65 for $65,000. Therefore, if the stock price rises above the strike price of $80, David will lose $70,000 - $65,00 = $5,000 - $1,500 = $3,500. If the stock price drops to $63, David cannot exercise any leg because they are both Out-Of-The-Money (OTM). Hence, the credit spread option will expire worthlessly, and David earns only the net credit of $1,500. If the stock prices goes up to $67, David can not exercise the strike price $70 because it is out of the money, but David exercise the the price $65 and sell 1,000 shares for $65 = $65,000. To close the position, he will buy 1,000 shares at the stock price of $67 = $67,000, thereby realizing a loss of $67,000 - $65,000 = $2,000 - $1,500 = $500. Depending on the fluctuation of the price ranges between $67 and $70. Key Points * A credit spread option is a type of strategy which involves buying one option and selling second option. * The two options in the credit spreads strategy are of the same class and expiry but vary in the strike price. * As and trader executed the trades, he receives a net credit; if the spread narrows, he will profit from the strategy. Final Thoughts A credit spread option is an investment strategy involving buying and selling put or call options with the same expiration dates and different strike prices on the same securities underlying it.

Trade safe, Stay healthy.

Hope this post will enhance of knowledge of some traders.