Credit Spreads: Money no matter which direction

October 1, 2008 by Daniel Beatty

Do you know what one of the biggest problems with trading is? Knowing which direction the stock or index is going to go. It can either go up or down or even sideways, and then there is the factor of how much it goes up or down. With this kind of information it is easy to see that a stock can do one of five things on any given day. Down a lot, down a little, stay the same, up a little or up a lot. If you buy a call you are taking a 2 in 5 chance that you are correct and it will go up or up a lot, so basically 3 out of 5 times you are losing money.

Now selling an option such as selling a put betters your chances because now you win when the stock goes up a little or a lot or stays the same… you now have a 3 in 5 chance that you are correct and make money.

With a credit spread you increase your odds even more. When placing a bull put spread now if the stock goes up a little, goes up a lot, stays the same or even goes down a little - you still have a profitable trade. In fact as long as the stock does not break your sold put strike price you will have a profitable trade. Now I do not like to compare trading to gambling especially the way I trade but for ease of comparison placing a credit spread trade is like placing a bet for an over under. You are guessing that a stock price will be over or under a certain price - the strike price of the sold option.

I trade very conservative credit spreads because the odds of a winning trade are much greater than just buying or even selling an option outright. In fact the way I trade leaves me with an 80% chance of a winning trade every time I place a trade and I also know the amount of profit and the maximum amount of loss before the trade is even placed. Also I know when to get out of the trade to either reduce loss or lock in profit.

Many times people complain about trading credit spreads using out of the money options, because, yes you win 80% of the time, but one of the times you lose, wipes out all your winnings. The problem with that is that people are letting the trade extend too far into the loss. There are rules to follow so that if a stock moves a certain amount you close the trade, you do not take the maximum loss, why would you, if you have a choice not to? When a trade is obviously moving against you, you need to change something.

For more information on how I trade check out my ebook at http://www.conservative-options.com