Using stop losses with credit option spreads

Using a stop loss is definitely something I recommend when trading stocks or straight option plays but definitely not in a credit option spread.

Your loss with a credit option spread is capped it can not go any lower than the exact amount you risk. Which is why I like credit spreads. Your profit and your loss is calculated before the trade. It takes out a lot of the fear/greed emotion driving of a trade.

In fact here is a good example of a 35/32.50 DEC put credit spread trade that the Market Skeptic is holding on a particularly volatile stock, RIO, which shows this philosphy —> themarketskeptic.com/archive/2007/11/29/lesson-in-volatility-and-stop-losses.aspx Keep up the faith Market Skeptic because RIO is trading above $35 today!

credit option spread, credit spread, option spread, stop loss

Credit Option Spread on Walmart

A bull put credit spread on Walmart? I don’t know about that… You know that I like to follow Brent Archer and what his recommendations are, because he trades similar to what I do. Credit option spreads using out of the money options above or below strong support or resistance with gains around 5 to 15% per trade is my preference. Well he has a recommendation for a Bull put spread below the $40 range using January options. Here is his full commentary —>Wal-Mart (WMT) to grow Brazilian segmentHeres my comments on his trade as an armchair quarterback trader…LOL

 I like to follow your recommendations but on this one I think the reward is too low for the risk. Yeah WMT has to fall 12% but in this market with what I feel is going to be a very lack luster holiday season that could very well happen.Then again it could be my personal disdain of Walmart in general. Definitely not a store I like to visit, although their business practices are pretty shrewd to give the consumer the lowest price possible, I think their customer care… well… stinks and this will be their downfall. The beginning of the end and for a measly 4% with a two month hold on a company I do not like I will pass on this one.  

  Maybe the one time I am in disagreement with one of his trades. The first one I have noticed at least.

bull put spread, credit option spread, credit spread, option spreads

What to trade with credit spreads

I have been asked numerous times how do I find my stocks to trade credit spreads on? Traders that are new to this strategy especially like to ask that question. And I will tell you that I have set up a watchlist over the last few years and trade from my watchlist when I see possibilities arise; however that is not the monthly money maker for credit spreads.

I really use credit spreads on the indices and ETF’s, especially the SPY and the IWM (iShares). These are the most reliable for me to trade credit spreads on a consistent basis. Today was a big day for me as it confirmed for me that we are definitely in a BEAR trading market. The DOW broke 13,000, the SPY broke 145, looking at the trend lines we are bearish. SO this would bring out more bear call spreads. Look at IWM It has not been able to break 85 the ceiling and stay there, it has been on a downward trend ever since. The next support/resistance is 82 to 82.50, then 80 and now 77.50. I personally like the looks of a DEC 82/83 Bear Call Credit Spread. You can get it for about .10, not a lot of income, but a good safe trade for about a 11% gain for 30 days.

credit spreads, downward trend, iwm, support resistance

What is a Stock Option Credit Spread?

I have been placing credit spread trades on here for the past couple of months and realized that some of you may not even know what a credit spread actually is, so a stock option credit spread is …

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 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 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.

credit spread, option spread

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