Defined-risk trading: know your max loss before you enter.

Max loss is a decision, not a discovery

The single structural difference between professional and retail options trading is when maximum loss gets determined. In a defined-risk structure, the worst-case outcome is fixed by the position itself at entry — no gap, no halt, no overnight headline can make it larger. In an undefined-risk position (naked shorts, unhedged stock), max loss is discovered later, usually at the worst possible moment.

Deciding max loss before entry changes everything downstream: position sizing becomes arithmetic instead of hope, drawdowns become survivable by construction, and no single trade can end the account. It also removes the most dangerous decision in trading — what to do when a position is moving against you fast — because the floor was set before emotion entered the room.

Every structure on this page shares that property: the maximum loss is a known dollar figure, printed on the trade ticket, before any capital is committed.

Debit spreads: directional exposure with a hard floor

A debit spread buys one option and sells another of the same type, same expiration, further from the money. The long leg provides the directional exposure; the short leg subsidizes its cost and caps the upside. The maximum loss is simply the net debit paid — that money is the entire commitment.

A bull call spread (buy the 100 call, sell the 105 call) profits if the stock rises; a bear put spread does the same for a decline. Compared to a naked long option, the spread reduces the breakeven, cuts the cost of theta decay, and dampens vega — you are less exposed to being right on direction but wrong on volatility.

Credit spreads: selling probability, not prediction

A credit spread sells the option closer to the money and buys a further one as protection, collecting a net credit up front. The trade profits if the underlying stays away from the short strike — you are paid for taking on a defined, bounded obligation, and time decay works for you rather than against you.

The math is fixed at entry: maximum profit is the credit received; maximum loss is the width of the strikes minus that credit, times 100. A put credit spread expresses “probably not below X by expiration”; a call credit spread expresses “probably not above Y.” Neither requires the stock to move — only to not move against the short strike, which is why credit spreads are the workhorse of probability-based trading.

Iron condors: paid on both sides of a range

An iron condor combines a put credit spread below the market and a call credit spread above it. You collect both credits, and the position profits if the underlying finishes between the two short strikes. Risk stays defined because each side is a spread — and since the underlying can only finish on one side, the two wings share a single margin requirement.

Condors are a bet on range and on elevated implied volatility mean-reverting, not on direction. They work best when IV is rich relative to what the underlying actually does, and worst when a quiet chart suddenly trends. The full doctrine — strike selection, IV conditions, adjustments — lives in the dedicated iron condor guide.

Butterflies: precision structures, small debits

A butterfly buys one option, sells two at a middle strike, and buys one further out (e.g., buy 95, sell 2× 100, buy 105). The cost is a small debit — which is also the maximum loss — and the maximum profit lands if the underlying pins the middle strike at expiration.

Butterflies offer the best risk/reward ratios in the defined-risk family, sometimes 5:1 or better, in exchange for a narrow profit zone and payoff that mostly materializes close to expiration. They suit traders with a specific price target and patience; they punish traders who need to be paid early.

Position sizing: the risk-per-trade cap

Defined risk only protects the account if the defined amount is small relative to it. The standard professional convention is to cap risk per trade at 1–3% of account value: 1% conservative, 2% balanced, 3% aggressive. At 2% risk per trade, a run of five consecutive max losses — which will happen to every probability seller eventually — costs roughly 10% of the account, an entirely recoverable drawdown.

The sizing arithmetic runs backwards from max loss, never forwards from potential profit: account × risk cap ÷ max loss per contract = number of contracts, rounded down. If one contract already exceeds the cap, the correct size is zero — the trade is skipped, not shrunk by wishful thinking.

Worked example: a 5-wide put credit spread

The stock trades at 210. You sell the 200/195 put credit spread — short the 200 put, long the 195 put, same expiration — and collect $1.50. Before anything else, compute the number that matters most:

Note the order: the $350 max loss is evaluated first, against the account risk cap, before the $150 max profit is even considered. The trade risks $350 to make $150 — acceptable only if the probability of keeping the credit is high enough to make expected value positive. That probability question is exactly what the Decision Engine is built to answer.

• What is the max loss?
• What is the expected shortfall?
• What is the worst realistic scenario?
• What happens if the stock gaps?
• What happens if the event goes against me?
• How should I size this trade?

• Should I buy premium or sell premium?
• Should I use a debit spread or credit spread?
• Is an iron condor appropriate?
• Is the expiration too short?
• Are the strikes too aggressive?
• Is this a better trade as a spread instead of a naked option?