Put Credit Spreads: Defined Risk Income Strategy

What is a Put Credit Spread?

A put credit spread (also called a bull put spread) involves:

1. Sell a put at higher strike (collect premium)
2. Buy a put at lower strike (protection)

Result: Net credit received, defined maximum loss.

Anatomy of a Put Credit Spread

Example - AAPL at $180:

• Sell $175 put for $4.20 ($420 credit)
• Buy $170 put for $2.10 ($210 debit)
• Net credit: $2.10 ($210)
• Max loss: $5 spread - $2.10 credit = $2.90 ($290)
• Margin required: $290 (max loss)

Compare to naked put:

• Sell $175 put: $420 credit
• Margin: $17,500
• Spread uses 60x less margin!

When to Use Put Credit Spreads

Use spreads when: ✅ Stock is expensive (> $200/share) ✅ You want more positions with less capital ✅ You're using Reg T margin (not portfolio margin) ✅ You want defined risk ✅ Account is smaller (< $100K)

Use naked puts when: ✅ You want to own the stock ✅ You have portfolio margin ✅ Stock is reasonably priced ✅ You prefer simplicity

Strike Selection Strategies

Strategy 1: Narrow Spreads (High Win Rate)

Structure:

• Sell 0.25 delta put
• Buy 0.15 delta put
• Spread: $5-10 wide

Example - MSFT at $420:

• Sell $410 put (0.25 delta): $9.80
• Buy $405 put (0.15 delta): $6.50
• Credit: $3.30 ($330)
• Max loss: $5 - $3.30 = $1.70 ($170)
• Return on risk: 194% (if expires worthless)

Pros: High probability, good return Cons: Less credit than wider spreads

Strategy 2: Wide Spreads (High Credit)

Structure:

• Sell 0.30 delta put
• Buy 0.10 delta put
• Spread: $15-25 wide

Example - NVDA at $880:

• Sell $850 put (0.30 delta): $22.00
• Buy $825 put (0.10 delta): $9.50
• Credit: $12.50 ($1,250)
• Max loss: $25 - $12.50 = $12.50 ($1,250)
• Return on risk: 100%

Pros: Higher absolute credit Cons: Lower probability, worse risk/reward ratio

Strategy 3: The 1/3 Rule (Recommended)

Rule: Credit should be at least 1/3 of spread width

Example:

• $10 wide spread: Collect minimum $3.33
• $20 wide spread: Collect minimum $6.67

Why: Ensures favorable risk/reward (2:1 or better)

Probability Analysis

Understanding probability of profit:

Short Put Delta	Probability ITM	Your Win Probability
0.15	15%	85%
0.20	20%	80%
0.25	25%	75%
0.30	30%	70%

But in a spread, you don't lose everything if ITM!

Example:

• Sell $100/$95 put spread for $2.00
• Max loss: $3.00
• If stock expires at $97: Loss only $1.00 (not $3.00)
• If stock expires at $93: Loss is $3.00 (max)

Breakeven Calculation

Formula:

Breakeven = Short Strike - Net Credit

Example:

• Sell $200/$190 put spread
• Credit: $4.50
• Breakeven: $200 - $4.50 = $195.50

If stock closes above $195.50 at expiration: Profit If below: Loss (up to max)

Real Trade Examples

Example 1: AAPL Conservative Spread

Setup (AAPL at $180):

• Sell $170 put (0.20 delta): $3.50
• Buy $165 put (0.12 delta): $1.80
• Net credit: $1.70 ($170)
• Max loss: $3.30 ($330)
• Return: 51.5% on risk
• DTE: 42

Breakeven: $168.30 (6.5% below current price)

Outcome after 35 days:

• AAPL at $182: Both expire worthless
• Keep full $170 credit
• 51.5% return in 35 days (536% annualized)

Example 2: TSLA Aggressive Spread

Setup (TSLA at $260):

• Sell $240 put (0.28 delta): $15.00
• Buy $230 put (0.18 delta): $9.20
• Net credit: $5.80 ($580)
• Max loss: $4.20 ($420)
• Return: 138% on risk
• DTE: 30

Breakeven: $234.20 (9.9% below current price)

Outcome after 20 days:

• TSLA drops to $245: Short put ITM
• Roll spread: Close for $2.50 loss, open new spread
• Net: Small loss, live to trade again

Managing Spreads

Profit taking:

• 50% rule: Close when credit decays to 50% (e.g., sold for $2, buy back at $1)
• 70% rule: Close at 70% profit for safer trades
• Hold to expiration: Only if very confident

Adjustments:

• Roll down: If stock drops, roll short put to lower strike (collect credit)
• Roll out: Extend time, collect more credit
• Close: Take loss if convinced trade is wrong

Spread vs Naked Put: Side-by-Side

Scenario: MSFT at $420, want to sell puts

Metric	Naked Put	Put Credit Spread
Structure	Sell $410 put	Sell $410/$400 spread
Credit	$9.80 ($980)	$4.50 ($450)
Margin	$41,000	$550
Return on margin	2.4%	82%
Max loss	$41,000	$550
Assignment risk	Yes	No (covered)
Best for	Want stock	Want income

Verdict: Spread is 34x more capital efficient!

Advanced: Spread Width Optimization

Test different widths:

AAPL $180, selling $170 put:

Long Strike	Width	Credit	Max Loss	Return	Prob Profit
$168	$2	$1.20	$0.80	150%	82%
$165	$5	$1.70	$3.30	51%	80%
$160	$10	$2.00	$8.00	25%	78%

Sweet spot: $5 wide for most stocks (balance of credit and risk)

Combining Spreads with Wheel Strategy

Enhanced wheel approach:

1. Start with spread: Sell put credit spread
2. If threatened: Let short put get assigned
3. Exit long put: Sell the protective put for credit
4. Sell covered calls: Now running standard wheel

Example:

• Sell $100/$95 spread for $2.00
• Stock drops to $98, you get assigned at $100
• Sell the $95 put for $3.00 (it's worth money now)
• Net cost basis: $100 - $2 - $3 = $95
• Sell covered calls from $95 basis

Result: Better entry than naked put!

Common Spread Mistakes

❌ Too wide spreads - Poor risk/reward (> $20 width)

❌ Collecting < 25% of width - Not enough credit

❌ Selling too close to ATM - High assignment risk

❌ Forgetting about long put - It offsets your loss!

✅ 5-10 wide, collect 30-50% of width, 0.20-0.30 delta short put

Tax Implications

Spread holding period:

• If held < 1 year: Short-term capital gains
• Same as naked puts
• No special treatment

Wash sale warning:

• Closing spread at loss, reopening similar = wash sale
• Wait 30 days to reopen

Tools and Calculators

Use our spread tools:

1. Spread Builder - Find optimal widths
2. Probability Calculator - Assess win rate
3. Return Optimizer - Compare different structures
4. Margin Calculator - See exact requirements

Real Portfolio: Spreads in Action

$100K account, using spreads:

Stock	Spread	Credit	Margin	Count	Total Margin
AAPL	$175/$170	$210	$290	3	$870
MSFT	$410/$405	$330	$170	2	$340
NVDA	$850/$840	$420	$580	2	$1,160
META	$450/$440	$380	$620	2	$1,240
GOOGL	$145/$140	$220	$280	3	$840
JPM	$185/$180	$190	$310	3	$930

Total:

• Positions: 15 spreads
• Total margin: $5,380
• Total credit: $4,050
• Return on margin: 75% (if all expire worthless)
• Margin utilization: 5.4% of account

With naked puts, could only hold 2-3 positions!

Next lesson: Call credit spreads and iron condors.