Last Update 5 months ago
With a call credit spread, your maximum potential gain is the net credit you received when you opened the spread. Remember, this is what you’re left with after buying a call and selling a call to construct the spread. You realize your maximum potential profit if the stock price at expiration is equal to or below the strike price of the short call. If this happens, both calls expire worthless, and you keep the net credit.
Setting up a Call Credit Spread
For example, imagine the fictional MEOW company is trading at $100 per share. You’re pessimistic about the company’s outlook and decide to open a call credit spread on MEOW. Here’s how it works:
- You sell one call option with a strike price of $110, receiving a $5 premium per share (this is the short call).
- At the same time, you buy one call option with a strike price of $115, paying a premium of $2 per share (this is the long call).
- Both calls have the same expiration date.
- Note: The long call is less expensive than the short call because it’s further out of the money.
Maximum potential gain
The net credit you receive is $3 per share ($5 received - $2 paid). An options contract typically represents 100 shares, so your maximum potential profit is $3 multiplied by 100 shares, or $300. You can achieve this if the stock trades at $110 or less at expiration.
Maximum potential loss
But, if the stock rallies, you may experience a loss. The maximum loss you can experience on a call credit spread is the difference between the strike prices minus the net credit received. (I.e., You buy the underlying shares at the higher strike price and are obligated to sell them at the lower strike price for a loss, but get to keep the net credit.) This theoretical maximum loss may occur if the stock price is equal to or above the strike price of the long call — the higher strike price — at expiration.
In the MEOW example, the difference between the strike prices ($115 - $110) is $5. Subtracting the net credit received ($3) leaves $2. So, the maximum amount you could lose per share is $2.
If each contract represents 100 shares, that means potentially losing up to $200. You would lose this amount if the stock price is $115 or higher when the options expire.
Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices, number of contracts involved, and whether the stock pays a dividend.
What’s the breakeven point at expiration?
You break even with a call credit spread if, on the expiration date, the stock price closes at the strike price of the short call (the lower strike price) plus the net credit received.
In the MEOW example, the strike price of the short call is $110, and the net credit is $3. Adding $110 and $3 comes to $113. So you will break even if MEOW’s stock price closes at $113 on the contracts’ expiration date (the short call gets assigned and you sell MEOW shares at $110 while buying shares at $113, and the long call expires worthless). If the stock price falls anywhere below $113, you should profit.