This post is from: Credit Spread

The thing is, when rookie option traders very first hear of this strategy – very few of them seem to be able to fight off the temptation to bounce right into trading them – with way too much actual hard earned dollars on the line – and way too little preparation, knowledge, and know-how.

And it appears that a great amount of them – if not nearly all of them – immediately wind up finding their groins bashed in, their heads chopped off, their eyes poked out, and getting really, very, badly hurt.

Now before you start to get the wrong impression here, please, let me clear up some thing.

I actually LOVE credit spreads.

I think they are an absolutely wonderful and excellent way to trade.

And all those reports and claims about generating five to ten percent a month even though barely taking any time looking at the marketplace – and how the possibilities are so unfairly on the side of the credit spread trader – and how trading credit spreads are just like being the ‘house’ as opposed to the gambler – yes – I believe and agree with all those claims and tales as well. Actually, not just do I agree and believe those claims – I KNOW they are accurate – mainly because I watch it happen first hand in my very own trading account on a standard basis.

The trouble is – there is something very large that’s getting left out of all those claims and testimonies – and this one large thing is causing way to many fresh faced ‘hypnotized’ option traders to misunderstand this technique correctly from the start – and in a way it’s actually encouraging them to leap thoughtlessly into trading them with quite inaccurate expectations.

See, even though it might be accurate that the credit spreads (and the iron condor strategy) can generate yields of over ten percent monthly, and that they favour the trader by offering higher probabilities of winning (in some situations as much as 80 and 90 percent) – what is just not getting talked about is the risk to reward ratio of these trades – which can regularly be as high as ten to 1.

10 to 1! Which means that in order to obtain those 80 to 90 % probability trades you might very well need to risk 10 dollars to create just a single dollar – or to be more accurate – you have to be willing to lose $10,000.00 for the chance to make just $1,000.00.

And as my dear mother used to say – ‘that’s an honest to goodness awful smelling spoiled rotten deal’.

Because as soon as you start to do the math you uncover the fact that even with those glorious monthly returns with 80 to 90 percent probability of winning – all it takes is just one problem month to arrive and induce a loss that may entirely obliterate the eight to nine wins you’ve accumulated – or worse – in addition it could also wind up cleaning out the rest of your account.

However – all isn’t lost…

As I mentioned earlier, I love the credit spread. And the iron condor trade as well.

And – I regularly make really good income from both of them.

So certainly there’s a way around those problematic losing months and that nasty risk to reward.

Of course there is.

It’s all in how you go about managing the trade.

See, so long as you learn the proper way to first put these trades on, then blend that with a very easy, uncomplicated management procedure (see below) and several simple adjustment tricks (see below) – this risk to reward ‘problem’ is absolutely eliminated and no longer any trouble.

You just need to take some time BEFORE you go slap on a credit spread or an iron condor – and arm your self with a little bit of our ‘spread trading insight’. Learn a couple of our ‘tricks of the trade’ – so when those tricky months DO arrive (and they definitely will believe me) – you will know EXACTLY what you must do to immediately crush out that danger, adjust yourself and your credit spread and/or iron condor out of the difficulty, and truly enjoy these trades for all they are ‘really’ cracked up to be.

To learn more about how to properly place, manage, and adjust these trades for consistent income, sign up for our free option trading newsletter by clicking here.

This post is from: Credit Spread

The credit spread strategy is used by option traders ideally in non trending situations. The spread takes advantage of theta decay in options – as the day progress moving towards expiration day, all options are losing value – and in the case of the credit spread strategy – as long as the ‘sold’ strikes of the trade are placed well out of harms way (of the underlying reaching or ‘breaching’ them) these trades can usually expire worthless allowing the iron condor trader to keep the entire premium received.

The iron condor strategy is used by option traders ideally in non trending situations. The spread takes advantage of theta decay in options – as the day progress moving towards expiration day, all options are losing value – and in the case of the iron condor strategy – as long as the ‘sold’ strikes of the trade are placed well out of harms way (of the underlying reaching or ‘breaching’ them) these trades can usually expire worthless allowing the iron condor trader to keep the entire premium received.

Iron Condors are built from 2 individual credit spreads – one on either side – once again, placed as far out of harms reach (of the underlying touching or moving through them) as possible while still bringing in a respectable credit.

Placed above the stocks current price is a bear call credit spread – usually positioned at least one standard deviation away from the underlyings current value. Below the iron condor investor places a bull put spread credit spread – also usually at least one standard deviation away from the stocks current trading price.

During the duration of the trade, the underlying can fluctuate around just as long as it doesn’t do so too wildly – and just as long as it remains within the predetermined ‘range’ created by the sold credit spreads on either side.

This type of option spread can carry with it an extremely high probability of winning as in most months the underlying, if chosen correctly, should not too far away from it’s current position. In the months where the underlying DOES begin to move too far, too fast – the trader managing these positions should have an adjustment plan in place to contain and cut short losses – which can be significant with these types of trades due to the high probability of winning / poor risk to reward set ups. However, if one does understand the proper way to manage and adjust the iron condor trade during it’s few seldom months per year – this type of trading can be extremely rewarding.

This post is from: Credit Spread

Within about 15 minutes of putting this trade on – this trade had a profit of 2.5%. We closed it at this point – with 5 minutes left before market closing. Even though we closed it – we continued to monitor it as if we had left it on – and as the bell rang to close the market the trade was up another 2.5% for a total possible profit (had we held on until market close) of about 5% gain in around 20 minutes.

The screen shot above was taken as market closed on Thurs. This iron butterfly was placed at even money about 20 minutes earlier. Due to the vols falling back down after the huge drop, this trade shows a 5% profit made in about 20 minutes.

This post is from: Credit Spread

Tried as I might, I was never able to  liquidate any of that before it corrected itself and went back to showing the actual correct sum. Unfortunate really…

However, through out that huge drop, our Iron Butterfly trade did amazingly well.

About 2 hours prior to the craziness starting our position was down around $100.00.

With the market moving down we added a bear side adjustment. Then when everything hit the fan, even though we were well outside our profit tent area, the vols took this trade from what started as a $100.00 loss to over $1000.00 profit. See risk graph below…

Hedged Iron Butterfly During Dows 1000 Point Drop – May 6, 2010

This post is from: Credit Spread

There are numerous option spread strategies non directional option traders can use to profit from the market without having to ‘know’ or be necessarily ‘correct’ about market and/or stock direction.

These include the iron condor, the butterfly spread, the diagonal and the double diagonal, the calendar spread – the double calendar spread – and, the credit spread (also know as a vertical spread).

The credit spread can actually be found hidden within many of the above mentioned option spread strategies. For example, the iron condor is created from two individual and separate credit spreads – a put credit spread positioned down under where the stock being used is trading at – and a call credit spread put on up above where the underlying is ticking at.

The credit spread can also be found in the butterfly spread. It is the upper half of the ‘regular call’ or ‘traditional’ call butterfly – is the lower half of the put butterfly – and the iron butterfly is comprised from 2 credit spreads – both a put spread and a call spread.

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photo credit: hiwarz

This post is from: Credit Spread

The credit spread option strategy can be played with either call options or put options. A credit spread / vertical spread placed with calls is called a bear call spread – while those that are placed with puts are called bull put credit spreads.

An example of a bull put credit spread would resemble the following…

Sell 1 XYZ Stock 50 Put Option
Buy 1 XYZ Stock 45 Put Option

This is a bullish play – as the option seller placing this trade is of the opinion that XYZ stock will be either remaining nuetral over the next however many days there are to expiration – or that XYZ will be bullish.

As long as the investor is correct and XYZ remains above the 50 dollar strike price by expiration day, the trade will be a winner and the trader will be able to keep the credit that brought into their account upon the initiation of the trade.

This traded is called a bull put spread because even though it is a trade using put options – it is done so in a way that benefits if the stock or underlying proceeds in a bullish manner.

photo credit: Furryscaly

This post is from: Credit Spread

For the most part this option spread is used when the trader placing it feels that the stock being used will not breach the short strike chosen for the spread which does make this trade somewhat of a directional play.

For example, if option trader Jane felt as though AAPL would not move above the 220 price range before the May expiration, she might decide to sell a credit spread – a bear call spread – where she sells the 220 strike call and then purchases the 230 call above it in order to ‘cover’ herself. Let’s say for this vertical spread trade she generates a 5.00 credit.

If in fact AAPL DOES stay below the 220 level all the way until expriation, Jane gets to keep the credit which could bring in a very nice return in a relatively short amount of time.

What is nice about these trades is that they give the option trader quite a lot of ‘wiggle room’ to be wrong. For example, if AAPL was at the 210 level when the above trade was initiated, Jane would make money on the trade if the the stock went down, or – went sideways, or – even if it went a little bit up (as long as it doesn’t breach the 220 strike level). This means, that out of four possible scenarios, Jane wins on this trade if the stock winds up doing three of them – and loses only if the stock does ONE of the possible scenarios.

These types of probabilities are one of the main reasons why option traders love the credit spread trade so much.

This post is from: Credit Spread

When discussing option spread strategies, the opposite of the option credit spread is the option debit spread.

While credit spread option techniques bring premiums in the form of credits INTO a traders account, debit spreads do just the opposite as the title of this method suggests – it pulls a debit out of the account. Also – generally when credit spread are used, the investor believes – or at least ‘hopes’ that the vehicle being used will move in the opposite direction of the options being used.

For example – if a non directional trading person had the opinion a particular stock would move downwards, they might put on a call credit spread – in hopes that the underlying moves down and away from that sold call spread,

In the case of debit spreads, the trader who is utilizing this spread option either believes or hopes that the stock or ETF being used will move towards the direction of the options being used in the vertical spreads.

For example, in the trader has the opinion that a specific stock will be heading higher, instead of SELLING a call credit spread – that trader would instead BUY a call debit spread – or a bull call spread – which would then profit if a move higher did in fact happen.

Let’s look at an illustration of a call debit spread:

Buy 4 GLD 110 Calls
Sell 4 GLD 115 Calls

The debit – or the ‘cost’ of this trade is the difference between the two strikes of the trade. This trade profits when the underlying being used moves bullishly.

photo credit: petesimon

This post is from: Credit Spread

The bull put spread is one of the option spread strategies that option traders utilize either as a stand alone method to capture profits from a bullish stock, index, or ETF – or – it is a ‘component’ of one to several other option spread strategies – for instance the iron condor option, the butterfly spread, etc.

A bull put spread is composed of the sale of a put option and the purchase of a put option. In most cases, non directional trading participants who use this method will select the strike at which they sell their put option either near the money – or out of the money – below from where the market presently resides.

The trader will then acquire or purchase a put option below the level at which they sold – even further out of the money. The purpose of this purchased option is to ‘cover’ – or protect – the option which they sold – from significant losses if the vehicle being traded where to crash through the short put.

When this trade is initiated – it will immediately give off a credit into the traders account – and this credit is the difference between the option sold and the option that was purchased.

As the trade progresses and time begins to chip away at the the options (remember that options decay over time) as long as the stock being traded remains above the strike price level sold – the difference in prices between the sold option and the purchased option becomes narrower and narrower – finally reaching a point where the trader can purchase the bull put spread back for less than what it was sold for – or simply allow it to completely expire worthless on expiration day.

photo credit: temporalata

This post is from: Credit Spread

The put spread is one of the option spread strategies that can serve several different purposes. First however, let’s take a quick look at just what a put spread is. Here is an illustration -

Sell 7 DIA Strike 100 Puts Options
Buy 7 DIA Strike 99 Puts Options

This option spread will bring a credit into the traders brokerage account right away. That credit will be the difference between the executed prices of the two different spreads. This trade will make the trader profits as long as DIA does not breach the 100 level before or at the end of the expiration cycle. If the underlying DIA stays above the 100 price level through expiration – this trade can be profitable.

Probably the main way non directional trading investors utilize the put spread is in the way described above. It is used as a way to generate consistent profits – and the trades are placed because the investor believes the asset being traded will remain above the selected levels.

However, another way the put spread can be traded is if the investor wishes to purchase the underlying stock or index – however not necessarily at the levels where it is currently trading at. For example – let’s say that DIA is trading at 105. The trader would like to own shares of DIA – just not at 105 per share. However, the trader WOULD like to purchase DIA if it were trading at 100 per share. This would be a bargain.

So, the trader could sell a DIA 100 put and bring some premium into his / her account. If before expiration DIA drops below the 100 level, the trader could have the shares of DIA assigned – allowing the trader to not only get the stock at or around the 100 price he wished for – but in addition the trader also is able to keep the original premium brought into the account.

The above scenario is also referred to as ‘going naked’ – because the 100 puts were sold naked – or without any other asset to ‘cover’ them.

However – if the trader going ‘naked’ want to acquire some insurance just to make sure that DIA didn’t drop to 0 during the duration of the trade – instead of just selling the 100 puts naked – the trader could sell a put spread – selling the 100 put and buying a 99 put. This still brings a credit into the account – still allows the trader to purchase DIA at the 100 level if it drops there, it just in addition provides the trader with insurance from a catastrophic crash type scenario.

photo credit: Daran Kandasamy

This post is from: Credit Spread

There are a number of option spread strategies non directional trading investors can use to generate consistent income from the markets. These include: option credit spread, iron condor spread, butterfly option, diagonal spread, calendar spread, etc.

One of the more simple – or easier to understand spread option strategies is the credit spread – or the ‘vertical spreads’.

This trade can be used to generate passive income from the market while the one putting the bull put spread or bear call spread doesn’t have to be exactly ‘right’ about which way the underlying is headed.

With the option credit spread trader – say he puts on a bull put spread – which is the sale of a put option below where the stock is immediately trading at – and then the purchase of a put even further below.

With this trade, it can be profitable if the underlying asset goes up, goes nowhere, or even goes down a little. The only way this trade could realize losses is if the asset drops significantly – and even in that situation there are measures that can be taken to ‘adjust’ the position.

photo credit: dunzki

This post is from: Credit Spread

Perhaps my favorite option spread strategy is the credit spread – or sometimes also referred to as the vertical spreads.

The option credit spread is a basic building block option position for other option strategies, such the iron condor spread and
the butterfly spread.

This position is made up of a sale of one option and the purchase of another option (both need to be calls or puts) to ‘cover’ it. For example, a call credit spread on IBM might look as the following spread option example shows:

Sell 1 125 call
Buy 1 30 call

What the non directional trading investor in the above example is trying to accomplish is to sell the premium in the 125 call for more than is paid for with the 130 call.

Then, as time goes by and the option start to decay, as long as IBM remains below the 125 level – at some point the credit spread trader can close the position for profit – or simply wait until the end of the expiration cycle and let the options expire worthless – assuming of course that IBM never breaches the 125 level before options expiration.

photo credit: sarniebill1

This post is from: Credit Spread