Figure 1 below shows a risk/reward graph for a Bear Call Credit Spread on the Russell 2000 broad-based index (RUT).  In order to create this Bear Call Credit Spread we would open the following two option "legs" shown below:

Buy to open, RUT 10 contracts, 750 strike, January 2006 Call

Sell to open, RUT 10 contracts, 740 strike, January 2006 Call

Or alternatively written as:

Buy 10, RUT 750 Jan 06 Call

Sell 10, RUT 740 Jan 06 Call

Or Alternatively written as:

10 RUT Jan 740/750 Bear Call Spread

Options Risk/Reward Graph courtesy of Optionetics Platinum

Figure 1

Dissecting the name "bear call credit spread", "bear" denotes that we want the underlying RUT index to remain below 740, our short Call that we are selling, or writing.  "Call" denotes that the trade is made up of Call options; "Credit" denotes that we are collecting a credit (premium) and depositing the funds into our brokerage account upon opening the spread; the credit is the difference between the 740 Call that we sold, less the 750 call that we purchased.  Because the 740 call is closer to the underlying RUT index, it's worth more than the 750 call, thus the reason that we end up with a net credit.   "Spread" denotes that we are opening two legs - buying a call at one strike price, and selling a call at different strike price, but both in the same expiration month.  In this case, we are selling the 740 call  (we're getting on the "other side" of the trade, like being the "house" in a casino) and then we're buying the 750 call for protection to limit our risk.  The 740/750 Bear Call Spread is a "10 point" spread because it has 10 points between the buy leg and the sell leg.

This risk/reward graph (Figure 1) shows the underlying Russell 2000 Index (RUT) on the left, (Y axis on left is the price of the RUT index) and how the seller of this Bear Call Credit Spread on the right will either make or lose money. The X axis on the bottom right is the gain or loss on the spread in dollars.

When this trade expires in 55 days and if the RUT stays below 740, the credit spread would expire worthless for the "buyer", and we the "seller" of this spread would keep the premium of about $500.  If the RUT starts to climb into the 740 strike, we then would make adjustments, where these adjustment strategies are covered in the Learning Center.

For this particular credit spread, we the seller would need to lock-up $10,000 in maintenance in our brokerage account to open the trade, and these dollars will be un-locked when the spread is closed.  Our total risk capital to open these 10 credit spreads is the $10k of required maintenance, less $500 in premium that we collected when first opening the trade, or $9500.  In order to calculate a simple return on investment (ROI) one would divide the premium collected by the total risk capital, which is 500/9500 = 6%.  We generally collect 6% to 10% ROI on 30 day to 45 day credit spreads.

The Bull Put Credit Spread

Figure 2 below shows a Bull Put Credit Spread on the Russell 2000 index (RUT); as discussed above, this type of trade is called a credit spread because when we as a seller open this type of trade, we will collect a net credit in premium.  When this trade expires, usually in 30 to 45 days, and if the RUT stays above the 610 strike price, the credit spread will expire worthless for the buyer and we as the seller will keep the premium collected, which is about $500.  We  would open this credit spread by placing the following order:

Sell 10 contracts, RUT 610 strike, January 2006 Put

Buy 10 contracts, RUT 600 strike, January 2006 Put

Or alternatively:

Sell 10, RUT 610 Jan 06 Put

Buy 10, RUT 600 Jan 06 Put

Or alternatively:

10 RUT Jan 06 600/610 Bull Put Spread

Maintenance requirement for this trade is $10,000. ($1k required per spread)

Figure 2

EXIT