• Short 1 call.
• Long 1 call further out-of-the-money (at a higher strike and a lower delta).

<Risk chart of a credit call vertical on SPY retrieved from OptionStrat>

A credit call vertical is a “not bullish” option strategy where one call is sold and another call is bought at a higher strike on the same date. This is sometimes called a bear call spread. The reason we say this is “not bullish” rather than bearish is that you can make money without downward stock movement.

For example, opening a credit call vertical after the breach of a Call Wall can be a high-accuracy trade as the underlying slows down in that price range and likely turns around. What is also nice about a credit call vertical is that they allow for short calls to be harvested without needing to be long the underlying shares just to cover it, a dynamic which would introduce tail risk to the downside.

A trader would primarily use a credit call vertical if expecting any outcome except for the underlying price of the security to move up significantly. Hence, this is more of a “not bullish” trade than a bearish trade. This strategy also has a very strong win rate, but do not get overly enchanted by that because the reward/risk is still poor and these credit strategies occasionally have major setbacks. To get an edge over time, it is ideal to open credit call verticals into rallies and while call skew is expanding, which is generally when we see positive spot/vol correlation. 

Advanced: Enhancement and Skew Edge

A credit call vertical has defined risk. As with any vertical spread, it has an even number of contracts on both sides, and the upside opportunity and downside risk are both capped. When credit call verticals are OTM, their win rate is higher, but their max loss will exceed max profit. 

These credit call verticals are often a rational enhancement to short calls on index products. This is because SPY-like call skew is severe enough that the higher-strike calls offer a skew edge. In the below risk chart, we can see that there is only a low max reward and a very high max loss. This is characteristic of OTM credit spreads, which is generally balanced out by their high win rate. The max loss is limited to the difference between the call strikes, minus the net premium collected upfront. Max profit is the net premium collected upfront. 

Expert: Dynamics and Synthetics

One dynamic to consider is that if credit call verticals are not closed or manually rolled after breaching the money and becoming ITM, then time decay will contribute toward negative expectancy. This means that time decay stops being your friend even though it is a credit spread.  

As a quick point on strategy, opening with a credit call vertical is also a practical way to leg into long calls, after closing a profitable short leg. What this would look like is closing the short call for a profit, and then using that profit to subsidize part or all of the cost of the remaining long call. The risk would still be defined in this case, but with less total risk and some profit locked in. In contrast, legging out of a long leg is more dangerous because it strands the short option, which in isolation has unlimited risk if the price keeps moving against it. 

A credit call vertical is synthetically equivalent to a debit put vertical if swapping out calls for puts on the same strikes (long call for long put and short call for short put). This means that an OTM credit call vertical (bear call) has the same logical dynamics as an ITM debit put vertical (bear put) if on matching strikes. 

bearish: A trade is bearish if it would profit from a decrease in the underlying (e.g. stock or future) price. Likewise, a trade thesis is bearish if it is expecting the underlying to decrease. 

Call Wall: The Call Wall is the strike with the largest net call gamma. This shows us what the top of the probable trading range is (the upper bound).

credit: In an option strategy, there is a credit received from the time decay (theta) of short options or credit spreads. This is the premium which you receive and the counterparty pays for the opportunity to hold the position. The one receiving the credit gains income until the option expires but takes on risks which can lead to losses and be significant if from an open-ended position.

credit spread: In an option strategy, a credit spread is one that has a net credit received from short options that is greater than the cost paid on the long options. This means that there is no upfront cost of the trade (known as a debit) but there are risks (and obligations) which can lead to losses. This is also how short options work, but what a credit spread does is buy one or more options to reduce some of the risk. For any short option strategy, there is going to be obligations and assignment risk. The way assignment risk works is that short option holders can be assigned shares at any time; this risk becomes greater when an option is in-the-money and near expiration. In exchange for taking on risk, the option holder pays a premium as the counterparty. This premium gradually decays the value of the option over time as it is paid out. This time decay is measured by a first-order Greek known as theta.

defined risk: In an option strategy, if risk is defined then it is structured so that it has a max loss (capped total loss on a trade) rather than potentially unlimited loss.

edge: An edge in trading is a competitive advantage but not one that guarantees a profit. It can be any method, idea, or tool which helps to outperform randomness. One way to interpret an edge is that it has a positive expectancy, which means that it would prevail as net profitable after many (ideally hundreds or more) occurrences. A single losing trade can be a good trade the majority of the time and a single winning trade can be just lucky without an edge. The bottom line is that if you have edge in your trading then you have a positive expected value, where you should come out on top if your trading size is managed well enough that no single trade causes too much loss and allows for many attempts.

ITM (in the money): An option is in-the-money if it would still have some [intrinsic] value if the option expired with the underlying price where it currently is. Being in the money is entirely about the strike price beating the underlying price. ITM options cost more than options at or out of the money; they also have less extrinsic value. Additionally, ITM options have more deltas (immediate directional risk).

leg risk: A calculated risk based on foregoing the protections of an option spread by putting on one part of an options trade at a time, to try to gain better pricing. Leg risk usually pertains to a tactical delay for legging into a spread. For example, one might start with a long strangle, and then leg into a credit iron condor by trying to wait and open a wider short strangle at a higher premium amount. If achieved, it would give the trade more edge; otherwise, losses on the long strangle from time (or losses from a drop in implied volatility) means that it would have been better to open the strategy all at once. As another example, one might open a long call and then wait for a potentially sharp move up before writing a call (sell to open) at a higher strike; this would be legging into a debit call vertical. However, if the price of the call drops and never returns to its opening price, then it would have been safer to open with a spread at the outset. It is a more conservative approach to open with spreads. However, if wanting to take on leg risk, then it is safer to open with long legs first and then to leg into short legs (so that the risk remains defined).

long call: To be long (buy and hold) an option contract which has limited risk and unlimited potential gains from moves up in the underlying price. The max loss is the cost of the call. Going long on a call is a simple way to gain upside exposure to movement in an underlying security, however the underlying security (such as a stock) must outperform the premium placed on that call by the options market. In other words, a long call must beat the options market in order to profit. If closed early (well before expiration) then a long call must outpace the expected move (priced in by the options market) for a specific period of time. All long calls have long gamma and long vega but short theta. It is uncommon to exercise calls rather than simply close them for a profit, however a long call is frequently understood as a right to exercise (trade in the long call to be long 100 shares) if above the specified strike price. Synthetically, a long call becomes logically equivalent to a long put if also short 100 shares.

OTM: An option is out-of-the-money if it would have zero value expiring with the underlying at its current price. When an option is out-of-the-money, its entire price is made of extrinsic value, which is a premium that option buyers are willing to pay for an opportunity to make a profit.

rolling: Rolling is an option trade management technique that closes one option position and opens another. This can be done defensively to keep a position open while accepting an immediate loss. Rolling can also be done offensively to lock in profits and reduce risk while retaining some directional exposure. When doing very well on a long option position, it is standard to roll to a lower delta to lock in some profit and reduce risk. Rolling can be done vertically. But rolling can also be done out in time to further dates—to keep pressure on a directional thesis.

security: Any investment product that can be traded on an exchange, such as but not limited to stocks, futures, ETFs, options, bonds, mutual funds, and treasuries. 

short call: To be short (sell to open and hold) a call. Unless otherwise hedged, the owner of the short call has unlimited risk and only limited potential gains, which makes this an extremely dangerous strategy in isolation. If left to expire, a short call will achieve max profit if the price ends up underneath the strike price. Shorting a call is a way to express a thesis that one is “not bullish” such as what might be justifiably the case if testing a Call Wall from underneath; being “not bullish” is different than being bearish. For a short call to be profitable, the underlying security must underperform the premium placed on that call by the options market. In other words, a short call profits when the underlying security fails to beat the options market. To be closed early for a profit, there needs to be a decrease in implied volatility or the underlying must have increased less than the options market has priced in for that specific period of time. All short calls have short gamma and short vega but long theta. Short options also come with obligations instead of rights, which means that, at any time, shares can be assigned (100 short shares for each contract); assignment usually only happens when in-the-money and near expiration). Synthetically, a short call becomes logically equivalent to a short put if the trader is also long 100 shares.

short put: To be short (sell to open and hold) a put. Unless otherwise hedged, the owner of the short put has severe risk and only limited potential gains, which makes this an extremely dangerous strategy in isolation. If left to expire, a short put will achieve max profit if the price ends up above the strike price. Shorting a put is a way to express a thesis that one is “not bearish” such as what might be justifiably the case if testing a Put Wall from above; being “not bearish” is different than being bullish. For a short put to be profitable, the underlying security must underperform the premium placed on that put by the options market. In other words, a short put profits when the underlying security fails to beat the options market. To be closed early for a profit, there needs to be a decrease in implied volatility or the underlying must have fallen less than the options market has priced in for that specific period of time. All short puts have short gamma and short vega but long theta. Short options also come with obligations instead of rights, which means that, at any time, shares can be assigned (100 short shares for each contract); assignment usually only happens when in-the-money and near expiration). Synthetically, a short put becomes logically equivalent to a short call if the trader is also short 100 shares.

skew: Volatility skew is the difference between implied volatility amounts of different options strikes on the same date. Implied volatility is the expected percentage range over one year–based on option prices–with 68.3% confidence. Skew is one of the main edges to look for in an options trade, especially on vertical spreads (all options are on the same date). Sometimes it is a penalty dragging down a good trade, but it is nonetheless important to understand the extent of how much it can challenge a trade if knowingly accepting to take the opposite side of a skew advantage.

SPY: This is the largest ETF (exchange traded fund) and represents the S&P 500. As an ETF, it can be traded just like a stock. This represents nearly the 500 largest and most successful US companies that are publicly traded. Often when someone asks how the market is doing, you can answer by telling them how SPY is doing. The S&P 500 is also the most common baseline for other funds to be compared to, either in performance or as a measure of beta (relative correlation and percentage range).

strike: The price that an option is based on. A long call will expire worthless if the price of the underlying security finishes underneath the strike price, and a long put will expire worthless if the underlying finishes above the strike price.

synthetics: In options, synthetics are different structures that have the same logical dynamics, including the same max loss, max profit, chance of winning, and option Greeks. Synthetics are possible because options have the property of put-call parity. For spreads, long puts can be swapped for long calls and short puts can be swapped for short calls (and vice versa) in a way that creates synthetic matches without the need of adjusting deltas with shares. On single-leg options, however, puts and calls can be swapped in the same way, but require directionally-offsetting positions in the underlying security (such as a certain amount of shares).

vertical spread: Any option strategy which has all contracts expiring on the same date. In contrast to a horizontal spread (calendar) or diagonal spread (combination of vertical and horizontal strikes), vertical spreads are usually the most directional and also the easiest to manage. With vertical strategies, the main edge at play is usually skew (differences in implied volatility for different strikes on the same date). Implied volatility is the expected percentage range over the next year—based on option prices—with 68.3% confidence.