What about credit spreads?

So many write about credit spreads, but what about them? Are they reliable, are they risky, are they adjustable? Can I trade it on the weekly options? All this questions seems to arise when someone puts some kind of effort to try this strategy.

I’ve been doing this for a while and I must say that the first problem you face when you start trading credit spreads, is the risk you take. Normally you start looking to high price stocks like Apple and start with out of the money options.

So let’s suppose you want to place a trade in Apple very far away from the current price.

Assuming a 10K account.

You pick 430-420 (21 September):

  

Theoretically you get 45 USD (112-67) for every 1000 risked. If you place an order for 10 options contracts, you are gaining 450 USD for the 10.000 USD at risk. That's 4.5%! You just need that Apple stays above 430 to cash in the premium. If you do this every month then that's 54%!!!!

This is what everyone is selling in the webinars.

But what if the stocks falls to 440 in the next 10 days...

430 strike will start trading at 5 and 420 will trade at 2.5, which means that you're down around 2000 USD.

And if in the process Apple shows some kind of problem and the stock falls to 420? The 430 will start trading at 14.7 and 420 at 9, that sums around 5000 USD loss, which if we are speaking of a 10K account, that will be gameover for you.

So the question is: Does it make sense to risk so much for such a return?

No it doesn't...

So what's the problem?

The problem is called leverage! You are trading a possible exposure of 430.000 USD with a 10K account. Eventually it will end bad... It's a question of time.

The right mindset for a credit spread it the same for a naked put, which means you are willing to buy the stock if you get there. That's it! Don't expect the 4.5% steady income month after month.

Like a covered call strategy, you don't buy 100 shares and sell 10x more call options. You trade 1 option for each 100 shares.

Remember, leverage is the fastest way to blow up an account. Then again, many are doing it and are successful and that is the reason that in the end you will ignore everything i just wrote.

Good investing,

S.