In a credit spread, a high-premium option is sold and a lower-premium option is simultaneously purchased. When an investor or trader opens a position on an asset that has a written option that is worth more than the long option, they will receive a premium credit. For traders or investors who use a credit spread strategy, the net premium is the maximum profit possible. When the spreads between the underlying options narrow, the credit spread turns a profit.

A credit spread is the difference in yield between two debt instruments with varying credit quality, typically measured in basis points. It reflects the perceived risk of default associated with lower-rated bonds compared to higher-rated ones. For instance, a corporate bond with a higher risk of default will offer a higher yield than a government bond of the same maturity to attract investors, creating a credit spread.

Credit spreads widen during periods of economic uncertainty as investors demand higher returns for taking on more risk. Conversely, they narrow when economic conditions improve, signalling greater confidence in riskier assets. Credit spreads are crucial in assessing market sentiment, pricing debt securities, and guiding investment decisions in the fixed-income market.