A credit spread an option trading strategy in which you buy an out of the money option at a certain
strike price and then you sell an out of the money option at a different strike price of the same
month. As time goes on the options will decay in value and as long as the price of the stock does
not go past the sold strike price at the end of expiration you will receive a full credit winning trade.
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will
increase in price over the next month and you firmly believe that the stock will not go below $50.
You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for
$.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your
account or actually $75 per contract you trade. The risk of the trade or the amount of money per
contract you need in your account is $425 per contract. This gives you a return on investment of
17.5% in how ever many days till Feb expiration.
Lets take it out like a real trade -
It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you
Lets take it out like a real trade -
It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you
now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or
$500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case
the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes
above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even
price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the
stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you
will lose $2125.
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed,
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed,
and exactly how much money you will risk then credit option spread trading is for you. Your profit
margins will be between 10 and 20% on each trade - on some of the aggressive credit spreads
you can make over 50% - and there are techniques for changing your trade if it becomes a losing
trade to help you recover some of the loss and in some cases even make it a winning trade again
even though you were wrong on the direction of the movement of the stock.
Now the way that I suggest most beginning option traders to trade is with a high probability
conservative credit spread. The high probability credit spread trade consists of creating a trade
using out of the money (OTM) options to compose a credit. Lets use an example of a stock
trading at $55 that you feel is bearish, feeling it will fall and stay below $50. We can create a
credit spread by selling an OTM $65 Call for $1.10 and buying an OTM $70 Call for $.50 creating
a credit of $.60. The max value this is $5 (the difference between the strike prices) which makes
your risk $4.40 ($5.00-.60). This makes for a high capital risk making only .60 while risking $4.40
or a 13% rate of return. However the probability of the trade being successful is much greater
because already the stock has to move up 10 points just to reach your sold option. As it stands,
the stock will need to close below $60 at expiration of the options and since it already is below
$60 and you feel the stock is weak and will be going lower. The probability of it gaining 10 points
or 18% is unlikely. In comparison to a low capital risk trade using at the money and in the money
options to make the credit spread, the stock already being at 55 would have to to fall 5 points and
stay below $50 for a low capital risk trade to be successful. This is what makes this credit spread
a high probability of success and the preferred choice for beginning option traders.
To learn how to trade options in this manner, go to Conservative Options and check out the book
To learn how to trade options in this manner, go to Conservative Options and check out the book
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