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In finance , a credit spread , or net credit spread is an options strategy that involves a purchase of one option and a sale of another option in the same class and expiration but different strike prices.
It is designed to make a profit when the spreads between the two options narrows. Investors receive a net credit for entering the position, and want the spreads to narrow or expire for profit. In contrast, an investor would have to pay to enter a debit spread. In this context, "to narrow" means that the option sold by the trader is in the money at expiration, but by an amount that is less than the net premium received, in which event the trade is profitable but by less than the maximum that would be realized if both options of the spread were to expire worthless.
Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards. It is necessary to assess how high the stock price can go and the time frame in which the rally will occur in order to select the optimum trading strategy. Moderately bullish options traders usually set a target price for the bull run and utilize bull spreads to reduce cost.
It does not reduce risk because the options can still expire worthless. While maximum profit is capped for these strategies, they usually cost less to employ for a given nominal amount of exposure. The bull call spread and the bull put spread are common examples of moderately bullish strategies. Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards.
It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy. Moderately bearish' options traders usually set a target price for the expected decline and utilize bear spreads to reduce cost. While maximum profit is capped for these strategies, they usually cost less to employ. The bear call spread and the bear put spread are common examples of moderately bearish strategies.
To find the credit spread breakeven points for call spreads, the net premium is added to the lower strike price. For put spreads, the net premium is subtracted from the higher strike price to breakeven. The maximum gain and loss potential are the same for call and put spreads.
For example, one uses a credit spread as a conservative strategy designed to earn modest income for the trader while also having losses strictly limited. This is also a vertical spread. If the trader is bearish expects prices to fall , you use a bearish call spread.
It's named this way because you're buying and selling a call and taking a bearish position. If the final price was between 36 and 37 your losses would be less or your gains would be less.
Traders often using charting software and technical analysis to find stocks that are overbought have run up in price and are likely to sell off a bit, or stagnate as candidates for bearish call spreads. If the trader is bullish, you set up a bullish credit spread using puts. Look at the following example. Traders often scan price charts and use technical analysis to find stocks that are oversold have fallen sharply in price and perhaps due for a rebound as candidates for bullish put spreads.
From Wikipedia, the free encyclopedia. This article may be too technical for most readers to understand. Please help improve it to make it understandable to non-experts , without removing the technical details.
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