Put Credit Spreads Explained for Beginners
Generate Weekly Income with this Simple Options Strategy on SMALL accounts.
With the new flood of retail traders from platforms like Robinhood, options trading has garnered a new popularity
This article will explain how Put Credit Spreads work, and how you can use them to generate income in small-large accounts.
What is a Put Credit Spread?
A Put Credit Spread (which we will refer to as a “PCS”) is a Options Spread that utilizes both short and long puts to minimize risk, and earn credit.
When you open a PCS, you are writing/buying 2 different contracts:
- You are Selling a Put, and receiving Premium for it
- You are using part of the Put’s premium to buy another put under the Strike
When you open a PCS, you must hold cash as collateral. This can be calculated by the following equation:
(short Put Strike Price — Long Put Strike Price) x 100 = Collateral
Since buying the second Put costs less than the premium received from selling the Put, you end up with a net Credit to your account.
Now that I have explained the basics, lets clear any of your confusions with a simple example.
Put Credit Spread Example:
SPY is trading at 335 today
Now lets say that I am confident that SPY will stay above 330 for 1 month.
I only have $100 to spend on this PCS, so I have to pick strike prices that are $1 apart. For this example, I will:
- Sell a 30 DTE $330 Put on SPY for $6 in Premium ($600)
- Buy a 30 DTE $329 Put on SPY for $5.50 in Premium ($550)
Now that we have opened our PCS, lets break down our returns.
Our net credit that we recieved is 600–550 → $50
Our collateral needed was (330–329) x 100 → $100
Our % Gains on Collateral are 50%
Now lets look at all the possible outcomes on Expiration.
- SPY expires above $330: We walk away with a $50 profit.
- SPY expires at $329.50: We break even, because our $50 loss on our spread is offset by our $50 in premium that we receive.
- SPY expires between $329.50 — $329: We start to lose money, which can be calculated by (($330 — Expiration Price) x 100) — Premium ($50)
- SPY expires below $329: We reach our max loss, which can be calculated by the equation: Collateral — Premium
Great job, we just ran through a realistic example on what a Put Credit Spread would look like!
Now let’s look through some tips to maximize your profits, and finding that perfect balance between risk and returns.
Tip #1 → Choose a Stock that you are Bullish on
When you open a PCS, you are betting that your stock of choice will trade above a certain price.
Because of this, it is important to only open Put Credit Spreads on stocks that you are bullish on.
Do not choose a stock solely because of its high premiums, as they are high for a reason; that stock will be much more volatile than others.
Tip #2 → Follow a Concrete Exit Plan
When a PCS turns out to be too risky, or is near worthless, it may be better to try and close the position.
You should have a very clear exit plan that you will stick to no matter what, as PCS’s can reverse and tank very easily.
A very popular “Theta Gang” strategy is to close any positions once they reach 50% profits, and never close at expiration.
Tip #3 → Diversify Your Strategy
If you have a medium-large size account, then you will have enough cash in collateral to open up numerous PCS’s.
In this case, do not put all your cash on one stock, as if it reports bad news, your entire account could be wiped out.
Instead, choose your favorite stocks from each sector, or use ETF’s to lower your individual risk of a stock crashing.
Tip #4 → Dont Play for Pennies
Although there are many options strategies that utilize small gains over long periods of time, Put Credit Spreads are not one of them.
If you sell PCS’s for pennies or low premiums, then one bad trade will lose months worth of gains.
Although it may seem more risky, upping your strike price on a bullish stock can contribute to higher returns.
Tip #5 → Don’t Make Your Spread too Wide
When you open up your PCS to wider strikes, you are required to hold more cash as collateral, because your max loss is greatly increased.
If you want to play it safer, it may be beneficial to open up PCS’s at different strikes, rather than keeping your PCS wide.
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