WARNING! DON'T TRADE CREDIT SPREADS Until You Watch This FREE TRADING VIDEO! |
||||||
|
If you're new to our site, make sure to watch our FREE Online Option Income Trading Video by Going Here . Thanks for visiting!
Discuss this and other stock market related topics at www.internationalstockforums.com Credit Spreads, that is Bull Put Spreads and Bear Call Spreads are some of the most mythologised strategies in all of Option Land. This is part three of a video, exploding some of those myths and looking at the real truth of this strategy, warts and all.
![Racek nad Ostravicí [The Gull over Ostravice River]](http://farm5.static.flickr.com/4030/4368206174_74cf3b25eb_m.jpg)
Out of all the various non directional trading methods, it’s possible that one of the most talked about spread option is the credit spread - or also sometimes referred to as the option vertical spreads.
Perhaps one reason the option credit spread is so popular is that it can be looked at as being more of an ‘entry level’ option strategy. It is easier and more simple to comprehend than other option spread strategies much as the iron condor spread, the calendar spread - or even the butterfly spread strategy.
This option spread consists of only 2 legs - a sold leg closer to the money - and a purchased leg further out.
The purpose of this option strategy is to sell a strike where the credit spread trader believes the underlying won’t go to during the duration of the trade. If selected right, the trader keeps the premium originally brought into the trade (unless of course the credit spread option position is closed out prior to expiration).
This is an example of a bull put spread on SPY…
Sell 10 Puts at the 100 Strike Level
Buy 10 Puts at the 97 Strike Level
In this example, the trader putting on this trade can profit as long as SPY stays above the 100 dollar level through expiration.
The put spread option credit spread is a method of trading that can provide steady non directional trading income - as is done every month traditional credit spread players - BUT - it also a method that can allow an investor to ‘be paid’ to purchase a desired stock and/or index at a lower level from where it might be trading at currently.
There are investors who employ the ‘naked put strategy’ - which is done by selling out of the money puts ‘naked’ on underlying stocks or indexes or etfs which they would like to own anyway. The way of thinking here is this,
“I’d like to purchase SPY stock at where it is currently trading at 110. But I would LOVE to buy it at 100 per share. So what I will do is SELL the 100 SPY PUT. If SPY stays above 100 at expiration day - that’s fine - I just keep the premium I collected by selling the put and do it again. On the other hand, if SPY drops below 100 at expiration day - that is fine too - I will be assigned the stock - which I wanted to buy anyway - only now I get it at the price I wanted (100 per share) PLUS I can KEEP the original premium collected when I sold the 100 put! This is a Win - Win!”
The only draw back to this type of thinking is what happens if the underlying - SPY in this example - suddenly crashes - tanking down far below the 100 level?
The put spread is a solution to address this possibility. By selling put spread - or actually a bull put spread - say sell the SPY 100 put and buy the SPY 98 put - the trader is still allowed to bring in some premium ( the difference between the two strikes of the option credit spread) and can still purchase the underlying at a more desirable level (the 100 level if SPY finishes below 100 at expiration). What the purchased 98 put will do is cap the possible losses if for some reason SPY did TANK and crash below those levels.
photo credit: Paul Stevenson
An extremely popular option spread trading method among non directional trading enthusiasts is referred to as the credit spread.
This spread option - which is occasionally also called the vertical spreads - can be found in a number of different theta positive option trades - for example the iron condor spread. The iron condor option is simply two different credit spreads - a call credit spread and a put credit spread spaced some distance apart from where the stock being traded is currently trading at.
This option spread strategies is a trade that allows an individual to profit without having to be ‘right’ about market direction. Traditionally a credit spread / vertical spread is sold ‘out of the money’ from where the stock being used is trading at - and is placed at a strike level which the trader believes the stock will not reach or pass through before the chosen expiration month.
Here is an illustration of a put spread on the stock CHK
Sell 4 25 puts
Buy 4 20 puts
The above trade is called a bull put spread. In this scenario, the put spread trader feels that CHK will not drop below 25 before expiration day - and if the trader is right - he or she will be able to keep the premium received from placing the trade - which can in many instances be between 5 and 20% profit.
An interesting aspect of this particular scenario is that if the stock does drop and finish below 25 at expiration day, the trader could simply allow the stock to be put to him or her - actually getting the stock at the lower level while at the same time keeping the premium received as a bonus.
photo credit: neurmadic aesthetic
Non directional trading strategies consist of various different theta positive methods, including the option credit spread, iron condor, butterfly spread, calendar spread and double calendar spread, diagonal spread, and more.
A core strategy that can be found ‘within’ many of these strategies is the option credit spread - or vertical spreads. This option spread is a basic and very important ‘building block’ of many other option spread strategies.
One credit spread option found in numerous other available strategies is the bull put spread. For example, in the iron condor spread a bull put spread makes up the lower end of the trade. In the butterfly spread, or more specifically the iron butterfly spread, it also makes up the lower half of the trade.
The bull put spread profits when the underlying asset it is being traded with stays at or very near the same price level as when it was first place, or heads upwards.
Hence the name - bull put spread. It is a put spread that benefits under a bullish scenario.
Following is an example of a bull put option credit spread on the stock AUY
Sell 12 March Puts of AUY at the 10 Dollar Strike Level
Buy 12 March Puts of AUY at the 8 Dollar Strike Level
With this trade, we would want the stock being used, AUY, to remain and finish above the 10 dollar strike level at expiration - unless of course we wanted to purchase AUY at 10 dollars per share in which case we would hope AUY finishes below the 10 dollar strike level at expiration - which if it did we would be assigned the stock and still retain the original premium.
photo credit: jimbowen0306
l
Bull call spreads - which are a debit spread rather than a credit spread - can also be found in many non directional trading strategies. Option spread strategies that use debit spreads as part of their construction include butterfly spread, condors, etc.
The option credit spread strategy is a trading method whereby the investor using this strategy puts the position on for a credit. Debit spreads - which are also 2 legged option spread strategies like vertical spreads - are placed at a debit to the investor putting the trade on. Instead of having generating a credit into the account - a debit is taken out.
A call butterfly spread has a bull call spread embedded inside it. If we look at this butterfly spread we might not at first see it - but once we take the butterfly apart and break it into peices it becomes apparent…
Example of call butterfly spread position:
Buy 1 IWM Call Option @ $60
Sell 2 IWM Call Options @ $65
Buy 1 IWM Call Option @ $70
When we break this butterfly trade down - or break it apart - we can see what it is really composed of…
Buy 1 IWM Call Option @ $60
Sell 1 IWM Call Options @ $65
This is a IWM $60 / $65 Bull Call Spread. The other half of this butterfly spread is…
Sell 1 IWM Call Options @ $65
Buy 1 IWM Call Option @ $70
…a IWM $65 / $70 Bear Call Spread - which is a option credit spread.
photo credit: Frank Bonilla Abstracts.tv
A Credit Spread is an options trading strategy where the spread trader sells an option at a particular strike bringing in a credit - while at the same time buying a cheaper option at a different strike price to cover the position.
And example of a credit spread trade could look as follows:
Sell 1 80 XYZ CALL for $5.00
Buy 1 85 XYZ CALL for $1.00
Placing this trade, a credit spread trader would bring a $4.00 credit into his/her account ($5 - $1 = $4)
Traditionally, spread traders sell credit spreads that are OTM (out of the money).
They choose strikes to sell which they believe will not be breached by the underlying during the duration of the trade - or days left to expiration.
For example - in the above scenario - the credit spread trader who placed the 80 / 85 call credit spread believes that the underlying XYZ will not move above $80.00 before expiration day.
The way credit spread trades realize their profit is from option decay. If, in the above example, the underlying XYZ does not reach $80.00 by expiration day - both the 80 call and the 85 call will expire worthless - leaving the credit spread trader with with a $4.00 profit.
To Watch FREE VIDEO |
 |
