A Defined-Risk Spread Still Needs a Position Size

How many spreads should you sell? The question sounds settled by the word “defined”. A put spread has a floor under its loss, the broker shows that floor on the order ticket, and a trade with a known worst case feels as though it has already been sized. It hasn’t. The worst case is per spread, and the number of spreads is a choice the ticket leaves entirely to you, so a trader who sells ten because each one looks small has simply defined a larger risk.

The rules below come with their reasons. Each one closes a gap the word “defined” leaves open.

Know the loss, the gain and the break-even first

Take a hypothetical stock. You sell a $50 put and buy a $45 put. Same expiry, net credit $1.20.

The stock finishing above $50 keeps the full $120. Anywhere below $45, the spread loses its full $380. Between the strikes the result slides from one to the other, crossing zero at $48.80. The options break-even calculator will check the last figure for any strikes and credit you enter.

Size by the maximum loss

Pick the share of the account you are willing to lose on one trade, turn it into dollars, and divide by the maximum loss per spread. Round down.

One spread. It feels timid. On a $30,000 account the $120 it can earn looks almost pointless. The maximum loss is the only figure on the ticket you can rely on in advance, so it is the one the budget divides. The 1.5% is a hypothetical choice, and yours may differ. The risk management course starts from the same idea in its lesson on risk per trade in dollars.

The budget also applies across trades. Sell the same spread on three different stocks in the same industry and the account carries $1,140 of maximum loss, 3.8% of $30,000, on positions that are likely to fall together when the industry has a bad week. Each ticket sits inside the 1.5% budget on its own. Together they behave like one trade at roughly two and a half times the $450 budget. Adding up the risk on all your open trades before placing the next one catches this.

Never size by the credit

The common mistake runs the sum backward. A trader decides on the income first, say $600 from this trade, and divides by the $120 credit.

Wanting $600 has set the risk at more than four times the budget. The credit is what the market pays you to accept the maximum loss, so every extra dollar of income comes attached to $3.17 of possible loss on this spread, and sizing up for income means sizing up the loss in the same proportion whether you look at it or not.

The best objection is that a stock may seldom finish below the long strike, which makes the maximum loss look theoretical. Nobody can know how often a particular stock will, and the one expiry where it does is the one that decides whether the account survived the year. That is also where the way a short put’s margin requirement moves matters: a spread caps the loss, a naked put does not.

Know what early assignment does to the account

The short leg can be assigned before expiry. With puts this happens most often when the short put is deep in the money and has little time value left; with short calls, just before an ex-dividend date. Assignment on the $50 put means buying 100 shares at $50, which is $5,000 landing in the account overnight.

The long $45 put is still there. The loss is still capped at $380. What changes is the account. A $5,000 purchase can create a margin debit. It can start interest charges or hit the limits of a cash account. Decide ahead of time whether you would sell the shares at the open on their own or together with the long put.

Close before the final hour when the stock is near a strike

A stock that closes right at $50 on expiry day leaves you unsure whether the short put will be assigned. You may find out only after the market has shut. If it is assigned and the stock is above $45, the long put expires worthless, and you hold 100 shares at $50 with nothing under them until the next open. That is pin risk.

So close the spread before the final hour whenever the stock sits near either strike on expiry day, because the small slice of remaining credit you give up is cheap next to a night or a weekend holding stock you never meant to own and cannot hedge until the next open.

One spread at 1.5%, until the account or the width changes

The call holds for any defined-risk spread. Size from the maximum loss, never from the credit, and plan for assignment before it arrives. It changes with the inputs: a wider spread, a smaller credit or a larger account all move the count, and on a $100,000 account the same 1.5% budget allows three of these spreads.