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.