Credit Option Spreads
By: Daniel Beatty -
What is a credit spread?
Investopedia says "An options strategy where a high premium option
is sold and a low premium option is bought on the same underlying
security."
OK I know that is very vague, so lets see if I can do better.
It is a 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 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 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, 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.
Daniel Beatty has been trading options for several years and now teaches others how to trade specific strategies for free through his website creditoptionspreads.com or Option Spreads.
Article Source: http://www.articledashboard.com