How to sell Credit Spreads
for Safe, Steady Profits
Selling CREDIT SPREADS is how you can trade options with minimum risk where the deck is definitely stacked in your favour. With this strategy, TIME DECAY works in your favour, and margin requirements are low enough to make it possible for smaller investors. Even if the trade works against you by a certain extent, you still win. Using this strategy, I regularly make at least 15% per month on my portfolio, and have sometimes made up to 70% in one month on an individual stock that is trending strongly. These are not bad gains, especially for beginners, smaller investors and the risk averse.
What is a Credit Spread?
When you sell a credit spread, you simultaneously sell one option and buy one option for a stock as a single transaction. The options are traded for the same expiration month, with different strike prices and are either both call options or both put options. You sell the more expensive option, and buy the cheaper option, resulting in a credit to your account.
Here is an example:
Bear Call Credit Spread
Using trend analysis, you have determined that Stock XYZ is trending down (Bearish). It is quite a strong trend, so you feel secure in placing a trade. XYZ is trading at $100 per share, towards the end of May.
Sell XYZ 120 June Call for 0.80. Credit $80
Buy XYZ 125 June Call for 0.30. Debit (cost) $30 (further OTM, therefore cheaper)
Net Credit $50
You sell an OTM Call Option for XYZ for the closest expiration date (not more than one month out), at a strike price of $120. You simultaneously buy (this is done as one transaction) an OTM call option at a further out strike price (say, $125). You immediately collect the money for this sale. Say the first options costs $0.80, and the second costs $0.30, the difference is $0.50. Because options are always traded in lots of 100, you pocket $50. All you need to do is wait for the option to expire a month later, and you get to keep the money!
Bull Put Credit Spread
Using trend analysis, you have determined that Stock XYZ is trending up (Bullish). It is quite a strong trend, so you feel secure in placing a trade. XYZ is trading at $100 per share, towards the end of May.
Sell XYZ 80 June Put for 0.80. Credit $80
Buy XYZ 75 June Put for 0.30. Debit $30 (further OTM, therefore cheaper)
Net Credit $50
You sell an OTM Put Option for XYZ for the closest expiration date (not more than one month out), at a strike price of $80. You simultaneously buy an OTM Put option at a further out strike price say, $75.
Why buy the further out option? Why not just sell options?
It is simple. If your trade goes against you, and you have sold an option without protection (i.e. a naked option), you have a heavy obligation. You will be obliged to either sell the stock at the strike price (if you sold a call), which means you first need to buy the stock at a higher price (if you are ITM) and then sell it at a lower price. Or you will be obliged to buy the stock at the strike price (if you sold a put), even if the price of the stock is much lower than that price. This means you must have the money available to do that, and your broker requires a pretty high margin to cover your risk. You therefore buy an option at the closest next strike price as a cover or hedge against your trade going wrong.
Even before you get into the trade, you are protected! You have an upfront credit, and you have a very clear idea of how much you can potentially lose. In addition, as you will see, you can manage this trade so that you NEVER lose!
Here is a page with some real live trade examples
TOP TIP: Want to learn more? Here is an options trading video course that takes you step by step through real trades on the TOS trading platform. This course is excellent value for money.
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