Response to our options education this past week has been encouraging, so we continue
to educate on options strategies. One reader asked about my favorite options selling
technique, so here I share with you the credit spread strategy.
Most options players think that when bullish, they want to buy calls. But in less
predictable, choppy environments, often a safer strategy results from being a net
seller of puts. The primary difference occurs from the role of time decay, as a call
purchase must see the underlying rise to profit, while an out-of the money put sale
can profit if the underlying stays flat or even declines somewhat. Yet I'm not a fan
of selling "naked" options, as if a position explodes against you, the damage can be
quite painful. So what I do is I purchase another cheaper option as insurance.
Here's an example (for illustration purposes only). If you're bullish on the S&P 100
Index (OEX) at 470, and don't think it will drop below 460 by the June expiration,
you could sell the June 460 put at 9 and at the same time buy the June 455 put at 8.
On a 10-contract spread, this would net you $1000 before commissions. Your biggest
risk is if the index falls under 455 at the June expiration, at which point you would
risk losing $4000 on the 10 contracts ($5000 risk between 460 and 455 strike prices
minus the $1000 you initially collected). If you're right about the index not
dropping below 460 at the June expiration, you keep the initial $1000 collected,
which provides a 25% return on the $4000 margin you have to put up to cover your
worst-case risk.
Some people don't like the idea of risking $4000 to make $1000. I understand that,
but the key is what winning percentage you can generate. Based on the scenarios
where the market can rise, stay flat, or even drop by a little over 2% and you still
win, you should be hitting on 80% or more of your trades in this approach. I have
seen streaks of 90%+ over some years.
The risk is that you can lose all of what you put into a given trade, so risk must be
managed in situations where the market is moving dramatically against the position.
The other key is that you should not pyramid your profits in this strategy, but
rather stay with a fixed number of contracts per trade. This will prevent you from
giving back too much of your profits when a loser does occur.
I personally like using the index options on S&P 100 Index (OEX), S&P 500 Index (SPX)
and Nasdaq 100 Trust (QQQ) for credit spreads. You could use individual stocks with
this strategy, but then you increase the company-specific risk that adverse news can
cause a gap that takes you out of the game. The indexes give the increased stability
to allow you to apply the proper risk management to your trades. The liquidity in
these index options contracts is also excellent overall. When you place credit
spread orders, you want to place them simultaneously and specify a net credit. This
further helps your ability to get filled quickly.
I usually establish a credit spread position on an index just once per month. The
goal is to see both options in the spread expire worthless, allowing the credit
spread trader to pocket the initial credit collected. This is possible due to the
passage of time, which works in the favor of the credit spread trader, all other
factors remaining roughly constant. Generally most market conditions are appropriate
for credit spreads. Typically the credit spreads do best in periods when market
volatility is relative stable or declining or increasingly slightly. When volatility
is dramatically spiking higher (usually in a sharp downturn), a bullishly-oriented
position can get hurt from a quick adverse market move. I measure the trend in
volatility, and will tend not to initiate positions when volatility is trending
higher.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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