How to Trade Call Credit Spreads

Call credit spreads are a bearish options selling strategy. They consist of selling a call to an options buyer then buying another call further out of the money for protection. The combination of selling and buying a call produces a net credit. If price expires below your short strike by expiration then you keep the full credit. Many traders look to take profit around 50%. Watch our video on how to trade call credit spreads.

What Are Call Credit Spreads & How to Trade Them?

Call credit spreads are a bearish to neutral options trading strategy. They consist of a combination of a short call and a long call. Your goal, and max profit happens if price is below the short call strike at expiration.

Call credit spreads, also known as bear call spreads are one of the many options trading strategies available to traders .They’re a great way to protect your account while making money. Every retail trader should learn the process. 

Options have more moving parts than a stock does. Therefore, protecting yourself is necessary. In fact, risk management is essential no matter what trading style you use. Exploring different strategies is a must if you are to figure out what type of trader you are.

What Are Options?

Call Credit Spreads

Before we can really dive into call credit spreads, lets go over what options are. An option give you the right but not the obligation to buy or sell a stock at a certain price within a certain time.

One contract controls 100 shares. As a result, they’re a great way to grow a small account because you can trade large cap stocks without putting up the capital.

However, to successful trade options, you must understand how they work. Implied volatility as well as the Greeks affect profit and loss.

Options also allow you to make money in any market; up, down and sideways. Spreads such as call credit spreads are a great way to protect your account.

Now that we’ve talked about the basics of options, lets look at a more advanced strategy. Also known as a “bear call spread,” the call credit spread is used to capitalize on theta decay and downward price movement in the underlying security. If you’re bearish you like this strategy.

It simply consists of a short call and a long call. Your trade will be profitable when the underlying asset closes below the short call strike price when the expiration time rolls around.

The Breakdown On How To Trade Call Credits

  • Sell 1 call (this is the short call)
  • Buy 1 call (this is the long call) with a price above the short call

In fact, if you want real time trade alerts for spreads, check out our real time stock alerts page. You get real time entries and exits on trades we’re getting into and we often trade call credit spreads to help mange our risk when trading.

They work out pretty well if we do say so ourselves. You can check out our YouTube channel for the video recaps to see for yourself.

Call Credit Spreads Diagram

A Real Life Example of a Call Credit Spread

Let’s take DOW and assume it is trading at $90 a share. To employ a call credit spread, I would sell the 95 strike call for $2.00 and buy the 100 call strike for $1.00. In total, the net credit I receive for this trade is $1.00 or $100. Cool huh?

The best case scenario for call credit spreads is for the underlying security to decline or stay the same. So, if the DOW is anywhere below $53 at expiration (short strike price), your trade is a winner.

KEY: For this trade to become unprofitable, DOW has to rally $3.00 from the current price of $50 to $53. We can always close the trade anytime we want. Sometimes  I close the short side of the trade when I am wrong, and hold the long side through the momentum, and recoup some losses,  and even make some profits.

Our trading service is available to you if you want to learn more about different trading styles and techniques.

Profit and Loss

Maximum Profit = Premium You Receive (premium = money)

Maximum Loss = Width of Strikes – Premium Received

Break Even Strategy for Call Credit Spreads

Calculating the break-even point for the call credit spread doesn’t take much work. You add the net premium received to the strike price of the short call option.

In the case of DOW, the stock can trade up to $53.50 per share at expiration before the call credit spread loses money.

Don’t forget to plan your trade and trade your plan. With options, it’s important to know your break even price.

That goes a long way in helping you decide if the trade has the potential to be profitable. Don’t forget that with options, there are more moving parts that affect profit and loss. 

Take our advanced options strategies course.

Why Trade Call Credit Spreads?

Your primary goal with a bear call spread is to pocket the premium you get from placing the trade. Furthermore, they’re a fantastic way to take advantage of time decay, considering you cap your loss.

In fact, this is where the call credit spread option strategy shines. Check out our trading room if you want to see this in action. 

Depending on how far out of the money the credit spread is, you will make money if the underlying rises slightly in price. You make money if the underlying price doesn’t move, if it completely crashes or if it moves down slightly. It’s a win-win all around.

In a nutshell, call credit spreads are a hedged version of the short call option strategy. You are hedged because you purchase a long call to minimize your risk or loss. In the trading world, this is called “legging in” to a call credit spread.

Margin Requirements for Call Credit Spreads

What’s nice about call credit spreads is it’s a risk-defined trade. Therefore, the buying power required to employ a call credit spread is equal to the maximum loss minus the premium received for placing the trade.

In the case of DOW, the margin requirement is $170, which is also the maximum loss. However, the limited risk of this strategy also comes with limited reward. 

That’s not a bad thing though. Many times traders only want to trade the home runs. But protecting yourself with limited risk helps protect your brokerage account.

We’d argue that’s more important than trying to make $10,000 a trade. Not saying you can’t do that; but when you pair that with limited risk strategies, you’re protecting yourself.

What About Time (Theta) Decay?

In the case of call credit spreads, time decay is on your side. Time premium comes out of the short option leg of the trade, regardless of what direction the underlying security goes.

On the same token, the long call will also lose value due to time decay. However, since the long call is always further away from the short call, theta decay will always be higher for the short call.

In other words, this offsets the theta from the long call. Remember those moving options parts? Theta is one of them and a highly effective one at that. 

It either hurts or helps, depending on how you use it in your trade. Hence why taking the time to really study and practice options is important.

Do You Let Credit Spreads Expire?

Ideally, you’d like to close out your credit spreads before expiration and take profit. 50% POP (probability of profit) is a good place to take profit. If you hold until expiration you are at risk of assignment, however, your broker will take care of the process. It’s best to take profit and close a credit spread before expiration.

When Should You Close Call Credit Spreads?

As a general rule of thumb, close out the call credit spread when the premium approaches zero before expiration. What’s more, another great strategy to eliminate risk on a profitable spread is only to close out the short call portion.

Additionally, this means you can leave the long call alone; typically because it will be worthless. There’s no point really in selling it for $0.01. The fact of the matter is, the remaining long call becomes a free-ride.

If you’ve been in the options trading world long enough, closing out the call credit spread by first closing the short call is known as “legging out” of the spread.

Other Things to Keep in Mind About Expiration

Like all vertical options spread strategies, there’s a chance the price of the underlying will land somewhere between the short and long strike prices of the spread come expiration.

So you run the risk of potential assignment if the short call expires in-the-money and the long call expires out-of-the-money. An assignment risk exists for any stock option seller when the short option is in-the-money. However, it is infrequent.

Typically your options broker will notify you if you have any expiring options that might cause a negative margin impact on your account. But the reality is, you shouldn’t depend on your broker to monitor this for you.

You must watch your call credit spreads that are near-the-money the day of expiration to see if you’re potentially at risk for assignment.

Key Points of Call Credit Spreads

  • It’s a bearish to neutral strategy
  • You make money when the stock price goes down, stays the same, or slightly moves up
  • Limited risk, therefore, limited reward
  • It’s merely a short call with a long call.
  • The long call is used as a hedge to prevent upside loss – which can be unlimited.
  • Overall time (theta) decay is beneficial but is slightly offset by the long call option
  • Ally Invest is the best and cheapest broker to trade call credit spreads
  • The strategy is similar to trading a short call, except there is an added hedge of a long call.

Summary

A call credit spread is always a defined profit trade. And, because you hedge your position by adding a long call, call credit spreads are a great way to capitalize on premium decay while minimizing your risk of losing money. We like that!

As with all option spreads you trade, fees and commissions can add up quickly. So it’s worth your while to shop around different brokerages to find the best rates. 

Similar to shopping around for brokers, you’d be wise to shop around for quality education. If you’re new to trading, you need to choose where you get your trading education carefully. 

Luckily by becoming a member of Bullish Bears, you have access to quality education and mentors. Why don’t you try us out for a few weeks, you have nothing to lose! (Literally, we have a two week trial!)

We call spreads or call spread spreads a lot in our stock alerts – so be sure to check us out when you become a full member!

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