This strategy will profit if the stock closes above $41.74 by. This is a bullish strategy with limited risk of $374 and limited potential reward of $226. Note that C$41.74 is the break-even point for the Credit Put Spread. Short 1 SU April 20 expiry 44 put + Long 1 SU April 20 expiry 38 put A higher strike long put will reduce downside risk as well as potential profitability of the spread. The width in strike selection should be a function of your risk tolerance. The long put protects the investor in case of early assignment (long 100 shares) by providing protection against a deeper price drop of the assigned underlying shares. The investor’s forecast should be that of being ok with owning the shares below the 44 strike should assignment occur prior to or at expiration with the stock below 44. The credit spread has the advantage of time-decay over the debit spread however, the credit spread has a risk of assignment on the short put. Should SU rise or stay above the break-even point of C$41.74 (44 strike -2.26 =C$41.74) by expiration the investor will realize a profit. An April 20 expiry 44-strike put is sold at C$2.47 while simultaneously purchasing a 38-strike put at C$.21 cents for a net credit of C$2.26. The investor opts to sell a put credit spread. Investor A believes that SU (Suncor Energy) currently trading at $C41.74 as of Mawill remain in a narrow trading-range or move higher over the course of the next few months. Let’s examine the following Bull Put Credit Spread example: The major differences are the cash flows in the investor’s trading account and the potential for early assignment associated with both the credit call and the credit put spreads. It is interesting to note that the P&L payoff profiles are identical once adjusted for the net cost to carry. Just as we learned with debit spreads there are advantages and disadvantages with credit spreads. The credit call spread is also known as a bear call spread and is appropriate for a neutral-to-slightly bearish forecast. The credit call spread is composed of shorting a near-the-money strike while simultaneously purchasing a higher strike call. The bearish investor could choose to purchase a debit put spread or sell a credit call spread. The credit put spread is also known as a Bull Put Spread, as it is a slightly neutral-to-bullish strategy and an alternative to selling a high-risk single put. A credit is generated as the higher strike put has a larger value than the purchase of the lower put. The credit put spread entails being short a higher strike put while simultaneously being long a lower strike put of the same underlying and expiration. The bullish investor could initiate either a debit call spread or credit put spread. The maximum loss is the difference between the two strikes minus the credit received. Credit spreads also have a known maximum potential profit, namely, the credit received from the sale of the spread. Recall that debit spreads are a limited risk transaction, with the total risk being the amount paid for the spread and a known maximum potential profit. This week we will examine another form of vertical spreads: credit spreads and how they can be used. In a previous posting, “Bull Call and Bear Put Spreads, Pairing Option Strategies with Forecasts” we learned how to implement a debit spread for both calls and puts.
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