Credit spreads

The steps below are the order the trade is actually placed in, and the order matters: what has to be in the account before an option can be sold is what makes the obligation coverable. None of the steps mentions a price, because there is no options-chain feed behind this site — nothing on this page is a quote, and no premium named anywhere here is one that exists in the market today.

1. Pick a direction: a put spread if you are prepared to be wrong only below a level, a call spread if only above one.
2. Sell the option nearer the money and buy the one further from it, same underlying and same expiration.
3. The difference in the two premiums is credited to the account. That credit is the entire income of the trade.
4. The long leg is what defines the risk: without it the short leg's loss has no ceiling.
5. If both legs expire out of the money the credit is kept. If the underlying moves through both strikes, the maximum loss is taken.
6. Nothing about the position is covered by shares — this is capital at risk, posted as margin, not an overlay on a holding.

Every line below is a rule of how the contract works, not a forecast and not a price. None of it moves when the market moves.

What pays you

The net credit: premium received on the short leg minus premium paid on the long leg. Nothing else in the structure pays anything.

Best case

The net credit, kept if both legs expire worthless.

Worst case

The distance between the strikes, times 100, minus the net credit. It is defined, which is the point — but it is usually several times the credit that was collected.

Breakeven

Short strike minus the credit for a put spread; short strike plus the credit for a call spread.

Capital required

A margin account and a higher option approval level. The broker holds the maximum loss as buying power rather than the full notional, which is what makes the position small to open and expensive to be wrong in.

Broker approval

Spread trading; a margin account and a higher approval level at most brokers.

Assignment

Only the short leg can be assigned, and the long leg does not cancel it automatically. Assignment leaves you holding a real stock position — long or short — and its risk, until you exercise or sell the long leg. Assignment on a Friday can leave that exposure open across the weekend.

Why tax gets its own box here rather than a line at the end. Premium is not taxed the way a dividend is, the treatment can change depending on whether the contract expires, is bought back or is assigned, and being assigned turns an option trade into a share sale or a share purchase with its own consequences. The note below is the general US structure, not advice, and not a substitute for asking someone about your own return.

This is the half of the trade that arrives later. The premium is collected once, at the start, and it is the whole of what this position can pay. The obligation behind it runs for the entire life of the contract, and the list below is what that obligation costs when the market moves through it rather than around it.

Full explainer in the Learn library: Credit spreads. Run your own numbers with the covered-call yield calculator.