Options Trading Strategy # 1 – Credit Spreads

If you’re new to Options trading, you may scratch your head with the term “credit spread”. It seems daunting to hear such a technical jargon, but once you get to know what it is, it is very simple. It’s one of the great options trading strategies that you can use on a bear or bull market. Let’s start with defining some of the terms.

What is A Credit Spread?

A credit spread involves buying and selling of options of the same type (either a Call or a Put) but at different strike prices and profiting from the difference in the buy price and the sell price of the options contracts. This options trading strategy works on the fact that different strike prices for options contracts have different premiums associated to it. In the case of a credit spread, you will receive a credit, as you will be buying the lower priced option and selling the higher priced option of the 2 strike prices.

For Example:

Company XYZ – Put Option for $1.00 = 0.30, Put Option for $1.50 = 0.15

In the scenario above, you will buy the $1.50 Put @0.15 and sell the $1.00 @0.30, and this gives you a profit of 0.15 (multiplied by the number of contracts). When you enter into a credit spread, you will automatically get the money for the rate differential, but this is assuming the stock performs well and goes up. This options trading strategy is called the Bull Put Spread. When the stock price for Company XYZ goes up in value, the put options will reduce in value. Thus, if by the expiry date it is well and truly above the $1.50 price, then you get to keep the 0.15 premium you received at the start of the trade. If it doesn’t turn out to be above $1.50, then you will need to buy back the spread and settle your loss by paying the difference in the current spread and the premium of 0.15 you have received.

Bull Put Spread vs Bear Call Spread

As the names would suggest, a Bull Put spread is used when you view that the stock is likely to go above the strike price that you want to enter. The Bull Put spread involves buying and selling of put options at different strike prices, and is the credit spread strategy for a rising stock price. A Bear Call Spread, on the other hand, is used when you view the stock to go below the determined strike price that you want to enter. This is the bearish strategy for credit spreads, and involves buying and selling of calls at different strike prices.

Determining Strike Prices

Credit spread as an options trading strategy can require some skills in determining at what level and expiry date to enter. Knowing what strike price to go for depends on the technical analysis of the stock, and the amount of premium you receive from the credit spread. Obviously you would want to make it worth your while risking the money in the markets, so you have to ensure that you get a decent amount on the premium for the spread. However, having said that, you need to look at the charts to know at which level the stock is likely to reach on a certain date, generally the expiry date of the options contracts that you will be using. It is not as simple as picking the one with the highest premiums.

Knowing Your Risk

With credit spreads, the risk you take on is basically the difference in the strike prices of the buy option and the sell option, times the number of contracts. The spread will never cost you more than the difference in the strike price of the bought option and the sold option. Make sure you are prepared to take that risk, should the market not go to your favour.

Better Trading Outcomes

Trading is a skill that can be learned by anyone who wants to be involved in the financial markets. It is not rocket science, and even the dumbest person can be trained to do trading. To be a successful and better trader, however, is another story. While it is not impossible to achieve better trade results, a lot of beginner traders struggle to get to this level. There is a method to follow in order to achieve better trades and become successful with trading.

Follow A Trading Plan

To be a successful trader, you need to follow a trading plan. This is one big area that most people fail to do in trading and hence causing them to lose money and have a bad experience with trading. A trading plan is essentially a system that you follow to determine your entry and exit signals for trading. There are many ways you can formulate a trading plan to achieve better trades. One great example is by using company reports and industry-specific reports to determine if it’s a great time to buy or sell a stock. Another tool you can use to devise your trading plan is to look at technical analysis and use one or two indicators to determine when you should enter or exit from a trade.

Following a trading plan is crucial to a trader’s success. The trading plan ensures that you are not making guesswork without any backing or analysis on why you are trading a stock or security. It also ensures that you are able to time yourself well and take profits when you can, and cut your losses early before losing your entire trading capital. Being firm with these rules definitely helps with achieving better trades.

Risk Management

As mentioned on my previous post, trading risk management is an important aspect of trading, as it helps you determine how much you are risking on each trade and protecting your trading capital. Without risk management, there is a high chance that a trader will fail and lose his money. Risk management also enables you to be on a trade and get a good night’s sleep. Traders who get into a position without first assessing the risks have been known to lose lots of sleep with the unnerving situation they put themselves in. Risk management not only protects your trading capital, it also gives you as a trader a piece of mind and sense of confidence. This would then result in you getting better trades at the end of the day.

Developing Traders Mindset

Trading Psychology is one area that most successful traders have mastered, and one that should be learned if you are to achieve better trades and become successful. When it comes to trading, there are two major emotions that can affect our thinking: Fear and Greed. Fear happens either before you enter the markets, or while being on a trade and feared losing out. The same goes with greed. If you can master these emotions and not let these get in the way of your trading, you will achieve better trades and become successful. After all, all you need as a trader is to follow your trading plan to the letter, and this will make you become successful.

People who are starting out with trading may not necessarily know how to formulate a trading plan. This is when a great trading education company like Planet Wealth can help to guide you to making a trading plan by showing you the ropes and teaching you how to trade. Having an expert trader show you how to trade can accelerate your learning, and help avoid those mistakes that the expert traders themselves have experienced in the past. This can only ultimately lead to you achieving better trades and a mighty chance of succeeding in the markets.

The Place to Find Option Trading Tips

Options Trading is one area that not as many people know when it comes to trading and the financial markets. It is not as common to trade options as it is to buy stocks or shares of a company and make money from it. Yet still, there are a few who have learned how to trade options and become successful in making a consistent income from it. However, option trading requires more knowledge in order to be successful. It is not as simple as putting your money aside and hoping for it to grow in the long run. This website will offer some option trading tips and strategies to make an income from trading options.

Before you step your toes into option trading, the first thing that needs to be addressed is to get back to basics and understand what an option is, and the terminologies that come with option trading. The option trading tips will only be useful once we understand the basics and then start developing knowledge on the different ways to trade options. I started out learning option trading this way, and I believe that if you are to make money using option trading strategies, you need to know the basics and build your foundations right.

Option Trading Terms

When trading options, you are in fact dealing with contracts. Essentially, an options contract is an entitlement to buy or sell a certain stock or share at an agreed price and at a certain specified period. Before further delving deeper into the details of options contract, let us define certain words that have been mentioned in the above statement:

• Expiry Date – the agreed date on the options contract
• Strike Price – the agreed price at which the stock is to be bought or sold

Options contracts give the holder the right but not the obligation to buy or sell the stock of share on or before the expiry date at the strike price. This means that depending on the type of options, the holder of the contract may buy the stock or share if the share price hits or goes above the strike price, or sell the stock if the share price hits or goes below the strike price. If it happens that the holder of the options contract has to buy or sell the stock or share, this action is called “exercise”.

Why Trade Options

There are many reasons why traders and investors would trade options contracts. Two of the most common reasons are:

1. Stop-Loss – Options are used to protect assets (stocks in this case) from the possibility of the stock price dropping lower than what the stock holder is willing to risk. This forms as a stop-loss measure for the stock trader, as this will ensure that he or she doesn’t have to sell the stock any lower than the strike price regardless if the existing price of the stock at the time is lower.
2. Extra Income – Options can be used to generate extra income from the stock held by the owner. When selling an option to another party, the seller receives a premium for risking the possibility of losing his or her stock holdings. This premium is kept and earned by the seller of the option, regardless of the option being exercised or not.

Each market or country will have mostly similar concepts when it comes to options trading, and there will be slight differences with each one (i.e., the American options trading requires 100 shares of a stock to form a contract, whereas the Australian options trading requires 1,000 shares of a stock to form a contract). Learning these terms and strategies can take time, but with the help of a fantastic financial education and investment company like Planet Wealth, your learning and involvement in the options trading arena will be accelerated through their wealth of knowledge and experience. More of these basic option trading tips in the upcoming posts, so watch out for the next series of option trading tips!