Options 101 · Module 7 of 10

Buying vs selling, and defined-risk spreads

In this lesson

Compare long and short premium, and compute max loss, max gain, and breakevens for vertical spreads (debit and credit) and iron condors.

5
short parts
13
questions
~15
minutes
Read the whole lesson on one page

Buying vs selling, and defined-risk spreads: the lesson

Buying and selling premium

Buying premiumSelling premium
Pay up frontCollect up front
Risk is the price paidLoss can be large
Needs a bigger move than the price assumesProfits if the stock stays away from the strike

A spread adds a second option to change that trade-off.

The vertical spread

Buy the 50 call for 1.72 and sell the 55 call for 0.30. You pay 1.42 net, and the short call caps your gain at 55.

+$358$0−$14245505560Stock price at expiration51.42

Stock at $56.00: profit of $358

Breakeven
51.42
Max loss
$142
Max gain
$358
Bull call spread: long 50 call at 1.72, short 55 call at 0.30, at expiration. Max loss $142, max gain $358, breakeven 51.42.
  1. Step 1: Net debit: 1.72 − 0.30 = 1.42, or $142.
  2. Step 2: Max loss: the debit, $142.
  3. Step 3: Max gain: width 5.00 − 1.42 = 3.58, or $358.
  4. Step 4: Breakeven: 50 + 1.42 = 51.42.

Credit spreads

Take a put credit spread on the $50 stock: sell the 50 put for 1.72 and buy the 45 put for 0.22. The long put costs money, so it shrinks the credit to 1.50. In return it caps your loss. You sell the higher strike, so you want the stock to stay above 50.

+$150$0−$35040455055Stock price at expiration48.50

Stock at $51.00: profit of $150

Breakeven
48.50
Max loss
$350
Max gain
$150
Put credit spread: short 50 put at 1.72, long 45 put at 0.22, at expiration. Max gain $150, max loss $350, breakeven 48.50.

The iron condor

An iron condor is a put credit spread plus a call credit spread. On a $100 stock: sell the 90 put and the 110 call, buy the 85 put and the 115 call, for a total credit of 1.50.

+$150$0−$3508090100110120Stock price at expiration88.50111.50

Stock at $110.00: profit of $150

Breakevens
88.50 and 111.50
Max loss
$350
Max gain
$150
Iron condor 85/90/110/115 for a 1.50 credit, at expiration. Max gain $150, max loss $350, breakevens 88.50 and 111.50.
  1. Step 1: Max gain: the credit, $150.
  2. Step 2: Max loss: (5.00 − 1.50) × 100 = $350.
  3. Step 3: Breakevens: short put − credit = 88.50, and short call + credit = 111.50.

A high win rate isn't enough

This condor makes $150 or loses $350. How often must it win just to break even?

  1. Step 1: Each win pays $150. Each loss costs $350.
  2. Step 2: Break even when 150 × wins = 350 × losses.
  3. Step 3: That's a win rate of 350 ÷ (150 + 350) = 70%.

And a spread defines your worst case, it doesn't remove it. If the stock gaps through both strikes, you take the full max loss.

Worked example: Three spreads, worked step by step

Illustrative numbers, not real quotes.

First, a bull call spread: buy the 50 call at 1.72 and sell the 55 call at 0.30, same expiration.

  • Net debit: 1.72 − 0.30 = 1.42, or $142. That is the most you can lose.
  • Max gain: width 5.00 − 1.42 = 3.58, or $358, if the stock ends at 55 or higher.
  • Breakeven: 50 + 1.42 = 51.42.
Stock at expirationP&L per spread
45−$142
50−$142
51.42$0
53+$158
55+$358
60+$358

Second, a put credit spread on the same $50 stock: sell the 50 put at 1.72 and buy the 45 put at 0.22.

  • Net credit: 1.72 − 0.22 = 1.50, or $150. That is the most you can make.
  • Max loss: width 5.00 − 1.50 = 3.50, or $350, if the stock ends at 45 or lower.
  • Breakeven: 50 − 1.50 = 48.50.
Stock at expirationP&L per spread
40−$350
45−$350
48.50$0
50+$150
55+$150

Third, an iron condor on a $100 stock: sell the 90 put and the 110 call, and buy the 85 put and the 115 call, for a total credit of 1.50.

Stock at expirationP&L per condor
80−$350
85−$350
88.50$0
90-110+$150
111.50$0
115−$350
120−$350
  • Max gain is the credit, $150. Max loss is (5.00 − 1.50) × 100 = $350.
  • To break even over many trades, this condor has to win 70% of the time, because 350 ÷ (150 + 350) = 70%.

Education only, not investment advice. Options involve risk. Read the OCC's Characteristics and Risks of Standardized Options. Example numbers are illustrative.