Credit Spread Basics for Safer 0DTE Trades

Credit spreads are options strategies where you simultaneously sell and buy options of the same type (calls or puts) but with different strike prices, resulting in a net credit (money received) to your account. The key feature of credit spreads is that they have defined risk—you know exactly how much you could lose in a worst-case scenario. For 0DTE (zero days to expiration) trading, credit spreads offer a more conservative approach than buying or selling naked options, as they allow you to benefit from time decay and probability while strictly limiting potential losses. The two main types are bull put spreads (betting on prices staying above a certain level) and bear call spreads (betting on prices staying below a certain level).

Importance for Trading

Understanding credit spreads for 0DTE trading is crucial because:

• They provide a safer alternative to buying options or selling naked options
• They allow you to profit from time decay which is accelerated on expiration day
• They offer defined risk and reward with clear maximum profit and loss
• They can be profitable even if you're slightly wrong about market direction
• They typically have a higher probability of success than buying options outright
• They require less capital than many other options strategies

"Credit spreads are like selling insurance with a reinsurance policy—you collect premium upfront while having protection against catastrophic losses."

The Food Truck Insurance Story

Meet Miguel, who runs a successful food truck business in a busy downtown area. His approach to managing risk and generating income perfectly illustrates how credit spreads work in 0DTE options trading.

The Basic Credit Spread Concept

Miguel has been operating his popular taco truck for several years. Recently, he's been approached by other food truck owners who are concerned about the financial risk of unexpected equipment failures.

"Many food truck owners are one broken refrigerator away from going out of business," Miguel explains to his business partner, Sofia. "They've asked if I would consider offering a type of informal insurance against equipment breakdowns."

Miguel has developed a unique insurance arrangement that works like this:

For a premium of $100 per month, Miguel agrees to cover repair costs if another food truck's refrigeration system breaks down. However, to limit his own risk, Miguel simultaneously purchases backup coverage from a professional repair company for $40 per month that would cover any repairs beyond $500.

"This arrangement is essentially what traders would call a credit spread," Miguel explains. "I collect a premium of $100 upfront, but I limit my maximum risk to $460 by spending $40 on backup coverage that caps my liability at $500."

Sofia does the math: "So your maximum profit is $60 per month if nothing breaks, and your maximum loss is $460 if there's a major breakdown?"

"Exactly," Miguel confirms. "I'm collecting a net credit of $60 upfront ($100 received minus $40 paid), and my risk is clearly defined and limited. I can't lose more than $460 no matter how bad the breakdown might be."

"A credit spread is like selling insurance while buying backup coverage for yourself—you collect premium upfront while strictly limiting your maximum possible loss."

This illustrates the basic concept of a credit spread in options trading. Just as Miguel collects a premium for providing insurance while limiting his risk by purchasing backup coverage, traders who use credit spreads sell an option to collect premium while buying a cheaper option to limit risk. The difference between the premium received and the premium paid represents the net credit—the maximum potential profit on the trade.

Bull Put Spreads: Betting on Support Holding

As Miguel's insurance business grows, he develops different types of coverage for various scenarios. One popular plan addresses the concern of food trucks not meeting their minimum daily sales targets.

"Many truck owners worry about slow days when sales fall below their break-even point," Miguel tells Sofia. "I've created what I call my 'Sales Floor Protection' plan to address this concern."

Under this plan, Miguel offers the following arrangement to a fellow food truck owner:

For a premium of $80, Miguel guarantees that if the truck's daily sales fall below $800 on a given Friday, he'll pay the difference between their actual sales and the $800 threshold. However, to limit his risk, Miguel only covers sales down to $700. Below that level, the truck owner bears the additional risk.

"This is similar to what traders call a bull put spread," Miguel explains. "I'm essentially betting that sales will stay above the $800 level, which is like a support level in trading. If I'm right, I keep the entire $80 premium. If sales fall below $800 but stay above $700, I pay out some money but still might profit overall. My maximum risk is $20 plus any payout if sales fall to or below $700."

Sofia understands the concept: "So you're bullish on their sales staying above $800, but you've limited your risk if you're wrong?"

"Exactly," Miguel confirms. "My maximum loss is $100—that would happen if sales fall to $700 or below. In that case, I'd have to pay the full $100 difference between $800 and $700, which after subtracting the $80 premium I collected, leaves me with a $20 net loss."

"A bull put spread is like betting that a support level will hold while limiting your risk if you're wrong. You're essentially saying 'I believe prices will stay above this level' while defining exactly how much you could lose if you're incorrect."

This demonstrates how a bull put spread works in options trading. Just as Miguel bets that the food truck's sales will remain above a certain threshold while limiting his downside risk, traders who use bull put spreads bet that a stock's price will remain above a certain level (often a support level) through expiration. The premium received upfront represents the maximum potential profit, while the difference between the strike prices minus the premium received represents the maximum potential loss.

Bear Call Spreads: Betting on Resistance Holding

As summer approaches, Miguel develops another insurance product for the opposite scenario—protection against excessive demand that food trucks might not be able to handle.

"During summer festivals, some trucks face the problem of too many customers," Miguel explains. "They worry about running out of food or being unable to serve everyone, which can damage their reputation and lead to negative reviews."

Miguel creates what he calls his "Capacity Protection" plan:

For a premium of $70, Miguel guarantees that if a truck receives more than 120 customer orders on a festival day, he'll provide staff to help serve the additional customers. However, to limit his risk, Miguel only covers up to 140 orders. Beyond that level, the truck owner must manage on their own.

"This arrangement is like what traders call a bear call spread," Miguel tells Sofia. "I'm betting that customer orders will stay below the 120 level, which is like a resistance level in trading. If orders stay below 120, I keep the entire $70 premium. My maximum risk is if orders reach or exceed 140, in which case I'd have to provide staff for 20 orders."

Sofia calculates the economics: "So if each staff member costs you $5 per order to provide, your maximum cost would be $100 if orders hit 140 or above?"

"That's right," Miguel confirms. "My maximum loss would be $30—that's the $100 maximum cost minus the $70 premium I collected upfront. And importantly, no matter how many orders beyond 140 they receive, my loss is capped at $30."

"A bear call spread is like betting that a resistance level will hold while limiting your risk if you're wrong. You're essentially saying 'I believe prices will stay below this level' while defining exactly how much you could lose if you're incorrect."

This illustrates how a bear call spread works in options trading. Just as Miguel bets that the food truck's orders will remain below a certain threshold while limiting his upside risk, traders who use bear call spreads bet that a stock's price will remain below a certain level (often a resistance level) through expiration. The premium received upfront represents the maximum potential profit, while the difference between the strike prices minus the premium received represents the maximum potential loss.

The Probability Advantage

After running his insurance business for several months, Miguel reviews the results with Sofia.

"What I've discovered is fascinating," Miguel says, showing Sofia his records. "On my Sales Floor Protection plans, where I bet that sales would stay above $800, I've been right about 75% of the time. On my Capacity Protection plans, where I bet that orders would stay below 120, I've been right about 70% of the time."

Sofia is impressed. "Those are good odds. Is there a reason your success rate is so high?"

"Yes, and it's the key to why this business model works," Miguel explains. "I carefully select the threshold levels based on historical data. I don't set the sales floor at the average level—I set it somewhat below average, where sales only rarely fall. Similarly, I set the capacity ceiling somewhat above average, where order volumes only occasionally exceed it."

Miguel shows Sofia a chart of daily sales for one food truck over the past three months. The average daily sales are $900, but he set the protected level at $800.

"By setting the levels with some buffer from the average, I create a probability advantage," Miguel continues. "I'm not trying to predict exactly where sales or orders will be—I'm just betting they'll stay within their normal historical range most of the time."

"Credit spreads have a built-in probability advantage because you don't need to be exactly right about price direction or magnitude—you just need the price to stay on the right side of your short strike at expiration."

This demonstrates the probability advantage of credit spreads in options trading. Just as Miguel sets his insurance thresholds at levels that are likely to result in no payout based on historical data, traders who use credit spreads select strike prices that have a statistical advantage of expiring worthless, allowing them to keep the premium. This probability-based approach is particularly powerful in 0DTE trading, where time decay works rapidly in favor of the credit spread seller.

Managing Risk Through Diversification

As Miguel's insurance business continues to grow, he implements another important risk management strategy.

"One thing I've learned is the importance of diversification," Miguel tells Sofia. "Rather than selling just a few large insurance policies, I now sell many smaller ones across different types of food trucks and different locations."

Miguel explains his approach: "If I sold just five large policies for $200 each, a single bad day could wipe out all my profits. Instead, I sell twenty smaller policies for $50 each, spread across trucks selling different types of food in different parts of the city."

Sofia sees the wisdom in this approach. "So even if several trucks have problems on the same day, you're unlikely to face maximum losses on all your policies simultaneously?"

"Exactly," Miguel confirms. "Different types of food trucks have different risk profiles. Taco trucks face different challenges than ice cream trucks or pizza trucks. By diversifying, I ensure that a single event—like a heat wave affecting ice cream sales—doesn't trigger maximum losses across my entire portfolio."

Miguel shows Sofia his current portfolio of insurance policies, which includes coverage for 20 different trucks with varying terms, thresholds, and premiums.

"This diversification is especially important for short-term policies that all expire on the same day," Miguel notes. "If all my coverage was identical and expired on Friday, a single weather event could trigger maximum losses across the board."

"Position sizing and diversification are crucial for credit spread trading—especially with 0DTE trades where all your positions expire simultaneously. Never risk so much on a single spread that it could significantly damage your account."

This illustrates the importance of risk management through diversification when trading credit spreads. Just as Miguel diversifies his insurance policies across different types of food trucks and locations, traders should diversify their credit spreads across different underlyings, different strike prices, and even different expiration dates when possible. This diversification helps ensure that a single market event doesn't trigger maximum losses across all positions simultaneously.

Using Credit Spreads in Real-Time 0DTE Trading

How to Set Up a Bull Put Spread

Real-time example: SPY is currently trading at $450, and you believe it will remain above $445 through today's close. You're considering a bull put spread to profit from this view.

How to implement the strategy:

1. Sell a put option at the $445 strike (collecting premium)
2. Buy a put option at the $440 strike (paying premium)
3. Calculate the net credit: If you collect $1.20 for the $445 put and pay $0.70 for the $440 put, your net credit is $0.50 per share ($50 per spread)
4. Define maximum risk: Your maximum loss is the difference between strikes minus the credit received: ($445 - $440) - $0.50 = $4.50 per share ($450 per spread)
5. Understand profit conditions: You'll achieve maximum profit if SPY closes at or above $445 at expiration

"Setting up a bull put spread is like building a fence around your risk—you know exactly how much you can make and how much you can lose before you even enter the trade."

Action plan:

• Select strike prices based on technical support levels—$445 might be a recent support level for SPY
• Ensure the premium received is worth the risk—aim for at least 20% of the width between strikes
• Consider the probability of success—the further OTM your short strike, the higher the probability
• Verify that both options have adequate liquidity with tight bid-ask spreads
• Enter the trade as a single spread order rather than legging in with separate transactions

How to Set Up a Bear Call Spread

Real-time example: QQQ is currently trading at $370, and you believe it will remain below $375 through today's close. You're considering a bear call spread.

How to implement the strategy:

1. Sell a call option at the $375 strike (collecting premium)
2. Buy a call option at the $380 strike (paying premium)
3. Calculate the net credit: If you collect $1.40 for the $375 call and pay $0.60 for the $380 call, your net credit is $0.80 per share ($80 per spread)
4. Define maximum risk: Your maximum loss is the difference between strikes minus the credit received: ($380 - $375) - $0.80 = $4.20 per share ($420 per spread)
5. Understand profit conditions: You'll achieve maximum profit if QQQ closes at or below $375 at expiration

"A bear call spread is like setting up a ceiling on a stock's price—you profit if the stock stays below your ceiling, and your risk is clearly defined if it breaks through."

Action plan:

• Select strike prices based on technical resistance levels—$375 might be a recent resistance level for QQQ
• Consider implied volatility—higher IV means higher premiums, which benefits credit spread sellers
• Calculate your break-even point: short strike + net credit ($375 + $0.80 = $375.80)
• Ensure the risk-reward ratio makes sense—aim for at least a 1:2 risk-reward ratio
• Enter the entire spread as a single order to ensure proper execution

How to Select the Right Strike Prices

Real-time example: You're looking to place a 0DTE credit spread on AAPL, currently trading at $180.

How to choose optimal strikes:

1. Identify key technical levels: Look for recent support/resistance levels
2. Consider probability of success: Further OTM strikes have higher probability but lower premium
3. Evaluate risk-reward ratio: Closer strikes offer more premium but lower probability
4. Check option liquidity: Ensure both strikes have tight bid-ask spreads
5. Account for upcoming events: Be aware of any news that might impact AAPL today

"Strike selection for credit spreads is about balancing probability against premium—the further OTM your short strike, the higher your probability of success but the lower your potential reward."

Action plan:

• For a bull put spread, look at support levels below current price—perhaps $175 has been strong support
• For a bear call spread, look at resistance levels above current price—perhaps $185 has been resistance
• Consider using the short strike with approximately 70-80% probability of expiring worthless
• Keep the width between strikes consistent (often $5 for stocks like AAPL)
• Adjust based on your risk tolerance—more conservative traders should use further OTM short strikes

How to Manage the Trade Throughout the Day

Real-time example: You've entered a 0DTE bull put spread on SPY with short strike at $445 and long strike at $440, collecting $0.50 credit. SPY is currently at $448, and it's now 11:30 AM.

How to manage the position:

1. Set profit targets: Consider taking profits at 50-75% of maximum potential profit
2. Implement time-based exits: As expiration approaches, consider closing even if not at full profit
3. Watch key technical levels: Monitor support/resistance levels that might impact your position
4. Have a management plan for adverse moves: Decide in advance when you'll cut losses
5. Consider gamma risk: Be more aggressive about closing positions as expiration approaches

"Managing 0DTE credit spreads is about balancing greed and fear—you want to capture as much premium as possible while recognizing that risk increases dramatically as expiration approaches."

Action plan:

• If the spread value decreases to $0.20 (60% profit), consider closing the position
• If SPY drops toward your short strike ($445), be prepared to make a decision about closing
• Become increasingly conservative as the day progresses—what might be an acceptable risk at 10 AM may not be at 3 PM
• Consider closing the position regardless of profit level by 3:00-3:30 PM to avoid late-day volatility
• Remember that most of the time decay benefit has already occurred by mid-afternoon

How to Handle Trades Approaching Max Loss

Real-time example: You have a 0DTE bear call spread on QQQ with short strike at $375 and long strike at $380. QQQ has rallied and is now trading at $376, putting your spread at risk.

How to manage a challenged position:

1. Assess the situation objectively: Is this a temporary spike or a sustained move?
2. Calculate current loss: Determine how much you'd lose by closing now versus maximum risk
3. Consider adjustment options: Can you roll the position to a higher strike or later expiration?
4. Evaluate time remaining: Less time means less opportunity for further adverse movement
5. Make a decision based on probability: Is QQQ likely to close above your short strike?

"Managing a challenged credit spread is about making rational decisions under pressure. Having predetermined guidelines helps you avoid emotional reactions that often lead to larger losses."

Action plan:

• Calculate your current loss if you close now—perhaps the spread is trading at $1.50, representing a $0.70 loss from your $0.80 credit
• Consider the time remaining—if it's already 3:00 PM, QQQ may not have time to move much further
• Look at technical levels and momentum—is $376 a resistance level where QQQ might stall?
• If you believe QQQ could continue higher, consider closing to prevent further losses
• Remember that your maximum loss is defined—in this case, $420 per spread—which helps maintain perspective

Practical Tips for 0DTE Credit Spreads

1. Start with wider spreads (greater distance between strikes) until you gain experience
2. Trade small size relative to your account—no more than 2-3% risk per spread
3. Focus on high-liquidity underlyings like SPY, QQQ, or major stocks
4. Be selective with your setups—not every day offers good credit spread opportunities
5. Have clear management rules established before entering the trade

Remember, credit spreads offer a more conservative approach to 0DTE options trading by defining your risk and potentially increasing your probability of success. As options educator Dan Passarelli notes, "Selling premium is often more profitable than buying premium because time decay works in your favor rather than against you." By mastering credit spreads, you can potentially generate consistent income while strictly limiting your risk—a powerful combination for both beginning and experienced options traders.