The structures in lessons 3 and 4 carry nearly the full downside of a stock. A credit spread removes most of it: you sell one option and buy a cheaper one of the same type and expiry further from the price. The long option caps the loss, so the worst case is known before the trade is opened. An iron condor combines a put credit spread below the price and a call credit spread above it. Formulas and a first example are in the Learn articles on credit spreads and the iron condor; this lesson is about the choices that determine whether these trades work.
Defined risk in numbers
A stock trades at $200, 35 days to expiry. A bull put spread sells the 190 put for $3.70 and buys the 185 put for $2.35.
- Credit: 3.70 − 2.35 = $1.35, or $135 per spread. This is the maximum profit.
- Maximum loss: width minus credit = 5 − 1.35 = $3.65, or $365.
- Breakeven: 190 − 1.35 = $188.65.
- Return on risk: 135 ÷ 365 = 37%.
A bear call spread is the mirror image above the price. Put the two together on the same expiry and you have an iron condor. With the stock at $100: sell the 92 put for $0.75 and buy the 87 put for $0.20; sell the 108 call for $0.95 and buy the 113 call for $0.35.
- Credit: (0.75 − 0.20) + (0.95 − 0.35) = $1.15, or $115.
- Maximum loss: 5 − 1.15 = $3.85, or $385. Only one side can finish in the money, so the loss is one wing's width minus the total credit.
- Breakevens: 92 − 1.15 = $90.85 and 108 + 1.15 = $109.15.
Width: what it changes
For a fixed short strike, a wider spread buys a cheaper protective option further away. The credit rises, but the maximum loss rises faster:
| Bull put on the $200 stock | Credit | Max loss | Breakeven | Return on risk |
|---|---|---|---|---|
| 190 / 185 (5 wide) | $1.35 | $3.65 | $188.65 | 37% |
| 190 / 180 (10 wide) | $2.30 | $7.70 | $187.70 | 30% |
The wider spread has a slightly lower breakeven but more than twice the loss. Width is the main lever for the size of a defined-risk position: decide the dollar loss you accept first, then choose the width and the number of spreads that fit it.
Probability against payoff
Moving the short strike closer to the price raises the credit and lowers the chance of profit. The chart below uses model prices for 5-point put spreads at different short-strike Deltas.
In a model with no volatility risk premium, every point on these lines has the same expected value: zero. A higher chance of profit is paid for with a worse ratio of gain to loss, and vice versa. That is the most useful idea in this lesson. No choice of strike or width creates an edge by itself; the edge comes from implied volatility being higher than the volatility that follows (lesson 1), from disciplined management, and from avoiding events that options underprice.
A quick check: the simple break-even win rate of a spread held to expiry is roughly the maximum loss divided by the width. For the 190/185 spread, 3.65 ÷ 5 = 73%. If your honest estimate of the chance the stock stays above the breakeven is not clearly higher, the trade relies on hope.
When tested: close, roll or adjust
A spread is tested when the stock approaches or crosses a short strike. There are three responses:
- Close. Buy back the spread and accept the loss. Simple, cheap in commissions and spreads, and it frees attention for the next trade. For most traders this is the default.
- Roll. Close the spread and open a similar one further out in time, ideally further from the price, for a net credit. A roll adds time and lowers the breakeven, but it also extends the life of a losing position. Never roll for a net debit, and limit rolls per position.
- Adjust a condor. Move the untested side closer to the price to collect more credit. Because only one side can lose, the extra credit reduces the maximum loss, but it narrows the profit zone and adds risk if the stock reverses. Each adjustment pays two more bid/ask spreads.
The test for any adjustment: if you had no position, would you open the adjusted trade today on its own merits? If not, close.
Assignment and pin risk
US stock and ETF options can be assigned early, most often when a short leg is deep in the money with little time value, or a short call just before an ex-dividend date. In a spread the long leg still caps the loss, but you need the buying power to hold 100 shares per contract until you close.
The larger danger is at expiry. Suppose the 190/185 bull put spread is still open and the stock closes at $189.90. The 190 put is in the money and will normally be exercised; the 185 put expires worthless. You are now long 100 shares at 190, a $19,000 position from a trade designed to risk $365. If the stock opens Monday at $180, the loss is (190 − 180 − 1.35) × 100 = $865, far more than the spread's maximum. The reverse also happens: a stock that closes just above the strike can move after hours, and the holder can still exercise. This uncertainty around the short strike is called pin risk. The cure is simple: close spreads whose short strike is near the price before the final session ends. Cash-settled, European-style index options such as SPX cannot be assigned early and deliver cash rather than shares, which removes this problem but not the market risk.
How to apply it
- Entry. 30–45 days; short strikes around 0.20–0.30 Delta for single spreads and 0.15–0.20 for each side of a condor; short strikes ideally at or beyond the expected move and beyond the options walls; implied volatility rich relative to realized; no earnings before expiry. Compare the credit with the width: a very small credit leaves little room for costs and mistakes.
- Size. Number of spreads = the dollar loss you accept on this trade divided by the maximum loss per spread (lesson 7).
- Target. Close at about 50% of the maximum profit.
- Stop. Close when the loss reaches about twice the credit, or when the stock closes beyond a short strike.
- Time. Close or roll with about 21 days left; never hold a spread with a short strike near the price into the final close.
- Invalidation. A break of the level that justified the short strike, a shift from positive to negative dealer gamma, a jump in implied volatility, or a new event before expiry.
In Clear Tape
The strategy builder on the Options page builds bull put spreads, bear call spreads, iron condors and iron butterflies from the delayed chain. Spreads start near 0.30 Delta and condors near 0.16 Delta per side, with the wing set to about 2.5% of the share price rounded to the listed strikes and the expiry closest to 35 days; expiry, short strikes, wing width and Delta can all be changed. Each build shows the credit at mid and at natural prices, maximum profit and loss, breakevens, chance of profit, return on risk, the short strikes measured in expected moves (under 1× means an ordinary move reaches them), the chance of touching each short strike, and checks for earnings before expiry, strikes inside or beyond the walls, dealer gamma, wide quotes and thin open interest. The payoff chart shades the expected move, marks the short strikes and draws Today and In N days lines. The fit rating favors condors with positive gamma, rich options and no earnings before expiry. It is a Pro feature using the previous session's close; it places no orders. See pricing.
Common mistakes
- Choosing very far strikes for a high chance of profit and forgetting that the payoff worsens in step.
- Widening the wings to collect more credit without noticing that the maximum loss grew faster.
- Stacking adjustments on a losing condor until it no longer resembles any planned trade.
- Holding a spread through the final close with the stock near the short strike.
- Assuming fills at the mid price on four-leg trades in thinly traded strikes.
Summary
Credit spreads and iron condors cap the loss and make position size a matter of arithmetic: maximum loss is width minus credit. Their probability and payoff always trade against each other, so the edge must come from rich volatility and good management, not from a clever strike. Close early when the target is reached, close or roll by rule when tested, and never let a near-the-money short leg reach the final bell. The next lesson covers the conditions under which premium sellers should stand aside: volatility and event risk.
For educational purposes only. Not investment advice.