A Credit Spread is an options trading strategy that involves selling an option with a higher premium (price received for the option) and buying an option with a lower premium, with both options having the same expiration date and being either both call options or both put options.
For example, let’s say you want to trade options on Company XYZ, which is currently trading at $50 per share. You can create a Credit Spread by selling a call option with a strike price of $55 and receiving a premium of $2, and simultaneously buying a call option with a higher strike price of $60 and paying a premium of $0.50. This creates a spread where the option with the lower strike price and higher premium is sold, and the option with the higher strike price and lower premium is bought.
The goal of a Credit Spread is to profit from the difference in premium between the two options. If the stock price of Company XYZ remains below the sold option’s strike price of $55 until expiration, both options will expire worthless, and the seller of the spread will keep the entire premium received. However, if the stock price of Company XYZ rises above the sold option’s strike price of $55, the spread may result in a loss. The maximum loss is limited to the difference between the two strikes prices, minus the premium received for the spread.