Credit Option Spread exit strategy - roll up, buy back, or leave alone?

OK our credit spread for this month was a May bull put 1395/1400 spread that was easily sold for .65 on April 11. Many of you could have sold it for .75, but we will go with .65 because that was the example given.

Well now what has happened the past week is astonishing. The market has skyrocketted - (use caution here because it has done this on average volume.) So what do we do with our spread trade. Here are some exit strategies -

1.) hold on to it till expiration with it going so high and now having at least two levels of support between the current price and the spread we should be OK.

2.) buy back the 1400 put and sell the 1410 - this is a good choice as it does not raise the risk considerably with the sold put being right at the last level of support, but it does raise your capital risk because the spread is now larger. I would buy back the 1400 put for $3.60 and sell the 1410 for $4.30 this will net you another .60 in credit almost doubling your original credit. However now because of the increased capital risk your play becomes only an 8% gain

3.) buy back the entire spread for .45 making a gain of .20 in the last week and roll into the next spread trade taking a look at the 1410/1415 bull put spread for .70. This would increase your credit for the month to .90 or a 20% gain (averaging the two capital risks)

Now lets imagine if the market did the opposite and had dropped, this is how I would have exited the trade. If for any reason the SPX closed below 1410 I would close the trade, most likely for a loss. We could roll back into another lower spread trade say 1385/1390, but why would I if I had read the market or the stock wrong or thesituation has changed then I want out of the trade completely, take my loss and move on. So that is the trigger, if the indice or stock closes below the support I was using for my estimates in the trade then I close the trade. Otherwise I just wait.

Now there is another time I would close a trade early. Lets say the SPX continues its rise and my spread becomes worth only .20 or less, and we have a week or more left till expiration, I feel it is too risky to leave my trade open for the measly little credit left, just close the trade. Take the .45 or .50 gain and be happy.

bull put spread, capital risk, credit spread, exit strategies, spread trade

Another Credit Spread

Here’s a credit spread trade for you from blogger Brent Archer. It has a little more risk due to earnings coming out on Amazon on the 24th, but he explains this well in his post.

The two problems I do have with this trade are 1.) too much time involved, in his defense he can not use the May options because there is no credit available at the level he wants you to place the trade. 2.) There is not enough credit in the July options to make me want to hold it that long to eat away the time value. We would be looking at a .15 credit on a $2.50 spread or about .25 on a $5 spread. We are looking at a 6% gain in 3 months time. Not the exact type of trade I would be looking for but he makes a good argument as to why this would be pretty probable to be a winning trade.

Check out his post here..BloggingStocks

amazon, credit spread, spread trade

Questions, questions questions - Entries and Exits part 1

OK after putting out my first ebook on how I trade credit spreads - How to Trade Conservative Credit Spreads I have been getting several questions and a couple are similar so the next few posts are going to be answering those.

Questions such as…
How do I pick stocks?
What stocks are on my current watchlist?
How do you know when to enter?
How do you know when to enter to extract the most profit from the spread?
When exactly should you exit?
Do you use Volatility to trigger your trades?
Do you watch your trade everyday or do you look for trades everyday?

Well first and foremost I will tell you that the system found in the book is made simple specifically for learning the basics and that I like simplicity. It does not need a trigger, if the % gain is what you want which in my opinion needs to be between 10 and 20% gain, then it is a go, no trigger necessary. That is the trigger - if you have found a stock or index that follows all the characteristics set forth in the manual then pull the trigger and place the trade. If not, do not place the trade.

With that said lets go in more depth with exactly how I enter and exit trades. First Entries -

Indices - I use the SPX and OEX and sometimes the RUT. To enter the trade I choose an option month four to six weeks out from expiration. So yes I could be looking at this trade for up to two weeks before I may actually place the trade, waiting for all the qualifiers to line up - the percentage gain vs risk, the support/resistance lines, the probability of success, etc. I will check this once a day or every other day depending on volatility and index movement. It takes less than five minutes each day to determine if the index will work out for the trade.

Next I pick a strike price above or below the line of resistance or support, if the % gain is above 10% and all other factors are OK I will place the trade, no trigger except for above or below resistance or support, % gain above 10, and probability above 80 then the trade is triggered and it is a go. I place the trade.

Lets look at the SPX right now - step by step -
1.) I would choose month of expiration
May Options because we have 5 weeks left till expiration, which gives us some premium to work with.

2.) Where is support/resistance and what is the market doing right now?
SPX right now is just below resistance of 1450 and it is currently bullish, there is some weak support at 1440 and better support at 1410.
With this information, we are bullish and I usually do not play against the trend so we would want to play a bull put spread. Weak support of 1440 would provide better premiums but would not provide good probability of success, so we need to find a put spread at or below 1410.

3.) Check the Option Chains of SPX for puts below 1410
With a 5 point spread we want at least a .50 credit to be above a 10% gain.
So lets check 1400 and 1395 strikes - 1400 bid/ask 7.30/8.30 1395 bid/ask 6.70/7.00
This would give us a spread of between .30 and $1.60. I would shoot for the middle 1.60-.30=1.30 X 1/2 = .65. SO the spread we would ask for is .65 credit which is acceptable.

4.) Plug the volatility, current price, days out, support price and sold 1400 strike into the probability calculator and see what the result is…
volatility 11.72
current price 1448.39
days from expiration 37
support 1410
sold put 1400
Probability = 78%
Close enough to 80% for me but for a beginner maybe not, maybe you want to stick with definitely above the 80% mark.

So depending on what happens first thing tomorrow morning I would place this trade around 9:30 to 10:00 AM Eastern time.

The only caveat is the news. Earnings are coming and everyone is speculating bad news for earnings and that companies are not going to be doing as well. Many people are predicting a major drop in the markets due to bad earnings. So the contrarian in me says that is good because then one of two things -
1.) good because then it will not happen because everyone expects it.
2.) good because this speculation is already priced into the market and stocks will not fall that rapidly due to this pricing.

Next we will take on exiting this trade.

credit spreads, ebook, probability, spx, support resistance, trades, volatility