Credit Spreads for Income

Income Trading with Less Capital

Cash-secured puts and covered calls are great, but they require significant capital. To sell one put on a $200 stock, you need $20,000 in cash. Credit spreads solve this problem by capping your risk with a second option, reducing capital requirements by 70-90%.

A credit spread involves selling one option and buying another at a different strike. You collect a net credit — that is your income. Your maximum loss is defined and limited.

The Bull Put Spread (Bullish Income)

You believe a stock will stay above a certain level. You sell a put and buy a cheaper put below it.

Example: SPY trades at $500.

• Sell 1 SPY $485 put for $3.00
• Buy 1 SPY $480 put for $1.80
• Net credit: $1.20 per share = $120
• Maximum risk: $5.00 spread width - $1.20 credit = $3.80 per share = $380
• Capital required (margin): $380

If SPY stays above $485 at expiration, both puts expire worthless. You keep the full $120. Your return on risk is 120/380 = 31.6% in 30 days.

If SPY drops below $480, you lose the maximum $380. That is the worst case — defined and known before you enter the trade.

The Bear Call Spread (Bearish Income)

Same concept, opposite direction. You believe a stock will stay below a certain level.

Example: TSLA trades at $250.

• Sell 1 TSLA $270 call for $4.50
• Buy 1 TSLA $275 call for $3.00
• Net credit: $1.50 per share = $150
• Maximum risk: $5.00 - $1.50 = $3.50 per share = $350

If TSLA stays below $270, you keep the $150. Return on risk: 42.8%.

Why Credit Spreads Are Powerful for Income

Defined risk. You know your maximum loss before entering. No surprises. No margin calls on the spread itself.

Capital efficient. Instead of $20,000 for a cash-secured put, you might need $400-$500 per spread. A $50,000 account can diversify across 20-30 different positions.

High probability. By selling spreads 5-10% out of the money, you can structure trades that win 70-80% of the time.

Scalable. Want more income? Sell more spreads. Five $480/$485 SPY put spreads would collect $600 in premium with $1,900 at risk.

Selecting Your Strikes

For income trading, follow these guidelines:

Short strike (the one you sell): Place it outside one standard deviation — roughly a 70-85% probability of expiring worthless. On most options chains, this is shown as the delta. Sell strikes with a delta between 0.15 and 0.30.

Long strike (the one you buy): Typically $2.50 to $5.00 away from your short strike. Wider spreads collect more premium but risk more capital. Narrower spreads are more capital efficient.

Expiration: 30-45 days out. Same reasoning as always — theta decay accelerates in this window.

Real Portfolio Example

Here is a monthly credit spread portfolio on a $25,000 account, using roughly 60% of capital:

Total monthly income: $555 Total capital at risk: $1,945 Monthly return on risk: 28.5% Monthly return on total account: 2.2%

If all five positions win (which happens more often than you think when you select properly), you collect $555. Over 12 months, that is $6,660 or 26.6% annually on a $25,000 account.

Of course, losses happen. Expect 2-3 losing months per year. After losses, realistic annual returns are 15-22% depending on management skill.

Managing Credit Spreads

Take profits early. When your spread has captured 50-75% of its maximum profit, close it. Do not wait for expiration. Buy back the spread for a small debit and free up capital for the next trade.

Cut losers at 2x credit received. If you collected $1.20, close the spread if the loss reaches $2.40. This keeps any single loss manageable.

Do not fight the trend. If the market is in a strong downtrend, do not keep selling bull put spreads. Wait for stabilization or switch to bear call spreads.

Credit spreads are the building blocks. In the next lesson, we combine a bull put spread and a bear call spread into one trade — the iron condor.