Defined risk

A defined risk position is an options trade where the maximum possible loss is known and capped before you enter the trade. No matter what the underlying stock does, even if it goes to zero or gaps up 50%, you cannot lose more than the defined maximum.

Spreads are the primary structure for defined risk: bull put spreads, bear call spreads, iron condors, and debit spreads all have fixed maximum losses set by the width of the strikes minus the premium collected or paid.

Why defined risk matters:

• You can size positions with confidence, your worst case is known
• No margin calls from a position moving against you beyond the spread width
• Suitable for all account sizes and approval levels
• Sleep-at-night peace of mind that undefined risk positions don't provide

Defined risk vs undefined risk: Selling a naked put is undefined risk, if the stock goes to zero, your loss is the full strike value. Selling a bull put spread caps your loss to the spread width minus the premium collected, regardless of how far the stock falls.

The tradeoff: Defined risk structures collect less premium than their undefined risk equivalents, because the long option you buy to cap the loss costs money.

Example: Sell a $500/$495 bull put spread on SPY for $1.50 credit. Max loss = $5.00 − $1.50 = $3.50 per share ($350 per spread). No matter how far SPY falls, that's your worst case.

Related terms: Undefined risk, credit spread, debit spread, iron condor, bull put spread, bear call spread

---