What is credit spread option trading strategy
Theta decay works in favor of a put credit spread. Everyday, premium will be systematically priced out of the short option leg of the spread. Although premium will also come out of the long option leg of the spread, the premium that comes out of the short option leg will be greater and thereby offset the long option theta. If a put credit spread has reached its max profit, it should be closed out prior to expiration. The best practice for a profitable put credit spread is to only close out the short put, and leave the long put which will likely be completely worthless untouched.
Because the short put has no more room left to decay, it makes sense to close it out, because it has reached its max profit potential. The long, however, can only go up in value, so it is a freeride. Similarly, if a put credit spread has reached its max loss, it should be left alone, because there is always the possibility of the market moving in favor of the position.
The risk with all vertical credit spreads is the underlying asset expiring within the short and long strikes. Of course, the expiration risk depends on the settlement procedures of the asset that you are trading.
If the asset is cash settled, like the SPX, there is nothing to worry about. Typically the only instruments that are cash settled are stock indices and futures, like the SPX and ES, respectively.
If this happens, you will be long shares of stock for every short put. This is generally not a problem if there is enough buying power in the account to hold the position. If there is not enough buying power, a margin call could be issued. It is common practice for options brokers to reach out clients who have expiring options positions to notify them if a position will have a negative margin impact.
The put credit spread option strategy effectively presents a risk-defined way to sell put option premium, which is nice. However, the max loss for a put credit spread is always defined. Plus, like all vertical spreads, the put credit spread is not sensitive to changes in volatility. It does not reduce risk because the options can still expire worthless.
While maximum profit is capped for these strategies, they usually cost less to employ for a given nominal amount of exposure. The bull call spread and the bull put spread are common examples of moderately bullish strategies.
Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy. Moderately bearish' options traders usually set a target price for the expected decline and utilize bear spreads to reduce cost.
While maximum profit is capped for these strategies, they usually cost less to employ. The bear call spread and the bear put spread are common examples of moderately bearish strategies. To find the credit spread breakeven points for call spreads, the net premium is added to the lower strike price.
For put spreads, the net premium is subtracted from the higher strike price to breakeven. The maximum gain and loss potential are the same for call and put spreads. For example, one uses a credit spread as a conservative strategy designed to earn modest income for the trader while also having losses strictly limited. This is also a vertical spread. If the trader is bearish expects prices to fall , you use a bearish call spread.
It's named this way because you're buying and selling a call and taking a bearish position. If the final price was between 36 and 37 your losses would be less or your gains would be less. Traders often using charting software and technical analysis to find stocks that are overbought have run up in price and are likely to sell off a bit, or stagnate as candidates for bearish call spreads. If the trader is bullish, you set up a bullish credit spread using puts.
Look at the following example. Traders often scan price charts and use technical analysis to find stocks that are oversold have fallen sharply in price and perhaps due for a rebound as candidates for bullish put spreads.
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