How to Set Up a Call Credit Spread

Call credit spreads can be an effective way to profit when an option trader expects a stock to stay below a certain area. Many times this area is potential resistance in the form of pivot levels or maybe a moving average. Let’s take a look at how to implement this trade strategy.

A call credit spread — or as it is sometimes called, a “bear call spread” — is created by selling a call option and buying a higher strike call with the same expiration. Maximum profit is the credit received, and it would be earned if the options expire worthless (at or below the short strike at expiration). The maximum risk on the trade is subtracting the premium received from the difference in the strikes. The breakeven point is adding the credit received to the short strike. Let’s consider a recent potential opportunity where a bear call might have been considered.

When Amazon Inc. (AMZN) was trading around the $1,584 level in May, the chart looked like this.

At the time, there were some pivot levels that had acted like resistance around the $1,615 level. The stock had never closed above that level. A 1615/1620 bear call spread with less than a week to go until expiration could have been sold for about 0.65.

The $0.65 (or $65 in real terms) represents the maximum profit that could have been earned if the stock stayed at or below the $1,615 level at expiration. The maximum risk was $4.35 (or $435 in real terms) if the stock closed at $1,620 or higher at expiration (5 – 0.65). Breakeven would be at $1,615.65 (1,615 + 0.65) at expiration.

If the stock moved lower, traded sideways or rallied up to $1,615 by expiration, the trader could still earn the maximum profit. That gives the trade three out of four ways to potentially profit. As with everything in option trading, there are risk/reward tradeoffs. The trader is risking a lot more than the profit potential, but that comes with a high probability. Each should be evaluated before ever entering any trade.

John Kmiecik, Market Taker Mentoring

Trader Education