The
Winners of the Winning Secret
Credit Spread Writing
Contest
«««First Place Winner«««
We’ve Got to Talk!
by Robert Zucker
It was the summer of 2006. I had just returned home
from a trip to the
Knowing that I was in trouble, I turned to God and
asked Him for help. Within a few days, I believe He
answered my prayers starting with a phone call. It
was from friends of mine, Mike & Aneissa, who had
just returned from
They weren’t sure what an option was but they were
all fired up because they immediately called me when
they got back and said that the three of us just had
to have dinner because “we’ve got to talk!”
We met at the Macaroni Grill. I had the Chicken
Saltimbocca and if you’ve never had it, I do
recommend it…it’s a very tasty dish! Aneissa
ordered a salad but she didn’t eat much of it but
then again, not many girls do. Mike ordered the
“give me everything” platter and he gulped it down
in one bite. Mike eats everything and anything; in
fact, sometimes I think he eats “green meat” but
that’s another story.
As good as the meal was, all I can remember was them
quoting you Peter, saying “10% per month! 10% per
month!” Curious, Aneissa offered to loan me the
CD’s that she bought from you while on the trip. I
must admit that in beginning, I was lost with what
you where saying.
But I continued to listen to them over and over
again. When I was convinced it could work, I
enrolled myself in an academy that taught how to
trade the market. Every couple of months, it seemed
that I was flying somewhere to a weekend seminar to
learn the next phase of trading.
Shortly after my first course, I decided to try and
build a better mousetrap. Being a software
engineer, I believed that it would help enforce what
I’ve learned and could possibly lead to a new future
job opportunity. Every weeknight and weekend, I
coded and coded. If I wasn’t at a seminar, I was
studying and if I wasn’t studying, I was coding.
It’s taken 3 years to finish my courses and the
software and now I’m starting to see the fruits of
my labor.
Here are some guidelines and what I’ve noticed…
For Bull Put Credit
Spreads
Determining an
Outlook.
Consider 3 criteria: Price, Theta and Vega. For
price, you’ll want an outlook that is neutral to
bullish. For theta, you want theta to be positive;
it is your edge to “beating the dragon.” as Peter
might say. And for Vega, be bearish. Too much
volatility here is not your friend.
Structure.
For delta, select a spread whose delta on the short
put ≤ 0.20. For credit, you’ll want the net credit
to be ≥ 10% of the spread. Select a spread whose
short put ≤ support and finally, no more than 45
days out from expiration.
General Trend.
Moving averages are a great way in determining the
general trend of the stock. What’s great about
credit spreads is that you can be somewhat wrong
about the direction of the stock and yet still win!
For a moving average, consider using either a 40/80
EMA or 50/100 EMA. From everything that I’ve read,
traders prefer to use EMA(exponential)’s versus
SMA(simple)’s. Using EMA’s carry more weight. Of
course!
For Bear Call Credit
Spreads
Determining an
Outlook.
Consider the same 3 criteria as we did in the Bull
Put except this time, for price, you’ll want an
outlook that is neutral to bearish. As for Theta
and Vega, keep the same mindset as in the Bull Put.
Structure.
For delta, select a spread whose delta on the short
call ≤ 0.20. For credit, you’ll want the net credit
to be ≥ 10% of the spread. Select a spread whose
short call ≥ resistance and finally, no more than 45
days out from expiration.
General Trend.
See Bull Put.
For Iron Condors (my
favorite!)
Determining an
Outlook.
Again, consider the same 3 criteria as we did before
except this time, for price, you’ll want an outlook
that is neutral. Price moving = bad! Price
stagnant = good! As for Theta and Vega, you’ll want
to be more theta positive and vega negative than the
previous strategies.
Structure.
For delta, select a spread whose combined delta on
the short call and short put is ≤ 0.15. For credit,
you’ll want the net credit to be ≥ 15% of the
spread. And finally, you want the short strike on
the call to be above resistance and the short strike
on the put to be below support.
General Trend.
As mentioned above, you’ll want to select a stock
that is stagnant. A good indicator for determining
the strength of a trend is the Average Directional
Index (ADX). By definition, anything under 20 is
considered “stagnant” while anything above 20 is
considered “trending” and over 30 is considered
“trending strongly”. Using the ADX for selecting
Iron Condor candidates is definitely a tool you’ll
want in your toolbox.
As you can see, I’ve been a busy bee. I’ve taken a
great risk in time and money in trying to learn this
skill and I’m happy to say I have no regrets. Peter
was right. This is the greatest game on earth and
I’m sold on the idea. As for the software that I’ve
written, well, you can take a look below and see for
yourself.
Things are indeed looking brighter these days. I
still have a ways to go before I get back on my feet
again but I do feel that I’m on the right path.
Even though I don’t work in this industry, I am
looking for a new job and hopefully a new career.
Why even just this week, I received a call from a
recruiter in
As for my greatest victory, that is yet to come and
I’m sure it’s not too far off in the future. Peter,
when you say trade from anywhere, does that include
the
««Second Place Winner««
Live Long, Trade Well and Prosper!
I began trading options in the late 1980's. Those first few years taught me that, as simple as they seemed, options were not the easy "get rich" product they were touted to be. My main strategy was to buy calls and pray the stock went up so I could make some money.
Later, as I learned more, I included buying puts and threw a few covered calls in for variety. Each year I made nice gains (I'm so smart) but ended up giving more back (the market is out to get me. My trading and investing education was very slow since it was, essentially, self taught.
Then in early 2002 I discovered credit spreads. My first 2 spreads were on individual stocks which resulted in one win and one loss. Then I learned that indexes were much better underlyings so I began trading the QQQQ and graduated to the OEX which became my standard "bread and butter" medium. I finished that year with 29 wins and 4 losses and, for the first time, made money for the year.
By the end of 2003 I had made back all my previous year's losses and more with 40 wins and 2 losses. In 2004 I had 29 wins and 2 losses and was averaging $2600.00 per month. In 2005 I began adding a few individual stock credit spreads with mixed results. I ended that year with 50 wins and 4 losses. 2006 ended with 28 wins and 1 loss and 2007 ended with 36 wins and 4 losses.
Everything was rosy until the infamous 2008 crash. That was a very painful and educational year. I learned to follow my own risk management rules and NOT to listen to professionals.
I'll explain.
My own, self learned, loss management rules defined certain exit or adjustment points that would limit losses when a trade started to move against me. However, in early 2008 I attended a free seminar put on by a well known option broker and was told that after you put on a credit spread, and it moves against you, "let it ride". Don't worry, the odds are it will probably come back.
And they are right, in a normal market that usually happens.
But in 2008 that didn't happen. I had a large put credit spread that was losing money and I thought the market was grossly oversold (it was). I decided to follow the expert's advice and just "let it ride". Of course you know what happened in 2008.
The resulting loss on that trade would have been 75% LESS if I had followed my own loss rules. The lesson learned was to always expect a 2008 market and take your losses while they are small and manageable.
What could be better than credit spreads?
Iron condors!
An Iron condor is a call credit spread and a put credit spread on the same underlying and the same expiration date. So you have twice the return potential with the same risk. And to make them more effective, enter a call credit spread at the top of a market and leg into the put credit spread when (and if) the market moves into a bottoming area.
Credit spreads are a regular part of my trading arsenal. They provide me with a regular stream of income that I can't get with other strategies. So far this year I have 14 wins and no losses.
Live long, trade well, and prosper!
«Third Place Winner«
Needless to Say--I
Had to Take Closer Look
While my first experience with credit spreads was
watching my cousin (the principle at a large hedge
fund) trade them, I had no idea as to the power of
this unique strategy. All I knew is
that not too many years had past since I was an
active duty Army Lieutenant, while my cousin was
mowing grass to put himself through graduate
school..... now he lived in a multi-million dollar
home, owned a slew of exotic cars, took "huge"
vacations and threw XMAS parties with valet
parking!
Needless to say, I had to take a closer look!
Though I had been trading stocks, options, currencies, futures-and just about any other market you can fathom-for more than a decade, I had little-to-no-idea what writing options meant, or would mean to the future of my trading. My cousin's brief synopsis of his system made little sense to me....how do you sell something you don't own?
I had shorted stocks, but that was borrowing the stock from my broker, selling it short, buying it back at a lower price and pocketing the difference....not rocket science! But writing options?
So, I started buying every book/trading course I
could get my hands on. Most gave the big picture,
but offered very little as to the mechanics of
actually trading for profit. Eventually, I put the
pieces
together, opened a paper trading account with Think
or Swim, picked their brains and started trading.
At first, I couldn't understand how any professional trader could do this.....risk $4300 to make a $700 credit. I was from the school of thought that always looks for the 2:1 reward to risk scenario (or greater). How could you possibly risk 4-6 times the profit potential and stay in business?
My answer came 100 paper trades later....96%+ winners! THE LIGHT BULB.....Trading with a range of probabilities in my favor!! A Bull Put Spread could go up a lot, up a little, sideways, or even down a little and I still made money. The probability was 80% in my favor on every trade.
When I learned to increase my chances by using the Black-Scholes Model, as well as techniques for keeping the trade Delta Neutral, my confidence hit new highs.
I now trade real $ with Think or Swim and the rest is pretty much history. No, I don't live in a multi-million dollar home and I still haven't quit the day job; But I no longer have any worries about what I would do if I lost my job. Nor, do I have any worries about retiring as a relatively young man!
Empowered to say the least!
JHonorable MentionJ
Oh Credit Spread!
Credit Spread, oh
Credit Spread,
After another day of Options' loss,
I don't know how to face (my wife) the Boss,
If I Only would have known about the Credit Spread,
I could have gone with peace of mind to bed!
The knowledge of
Credit Spread lingers,
Meaning, the Credit Spread Package slips through my
fingers!
You Will Be Pleasantly Surprised
There is a famous quote attributed to University of Michigan football coach Bo Schembechler: "Three things can happen when you pass the ball, and two of them are bad."
The same goes for the market. The market can go up, down, or sideways. Typically only one of these directions helps your position.
But unlike a pass in football, a put credit spread can improve your chances of success by creating a trade that is "in the end zone" if the market goes up OR sideways.
I like selling put credit spreads right now because while the current market is trending upward, that trend is slow, and many times paying the volatility/time premium in straight calls does not prove to be a profitable experience.
An out-of-the-money put credit spread does not require the underlying to go up, it just needs to stay above the strike price of the short put. This greatly increases the chance of ending up with a profitable position.
There are many weeks in the past few months where the market goes up a few days, gets bombed in one or two bad days, and over the course of time doesn't seem to have accomplished a whole lot. This situation is ideal for the OTM put credit. And if your underlying does go up, your profit target will be reached sooner and you can exit early if desired.
Of course, as anywhere else in life there is no free lunch. The margin requirements on a credit position create a moderately high risk to reward ratio. On a $5 spread it is typical to aim for a credit of 30-50 cents (remember risk = spread - credit) if you are operating in the current (front) month of the contract, so it is not something you can forget to pay attention to.
You can generally get a higher credit by going farther out in time. Of course, then you have to wait longer to book your profit. With many pundits still predicting disaster for the markets in the coming months, I have preferred to keep my positions short-lived and maintain a certain amount of nimbleness.
I have found positions returning a 70-cent or more credit, but these can be a bit dangerous because they contain high-volatility options which can drop into the money very quickly. I have had to bail out of a couple of these positions only to have them go back out of the money the day before or even on the day of options expiration and finally expire worthless. Arggh!
How do I decide where to place the spread? I choose as the short strike a level below recent support. The longer the stock has been above that support, the better. The farther above (below?) support you go, the less risk you take on, but the reward will drop correspondingly.
On some of the financial stocks, for example, the current volatility suggests it is probably wise to give yourself this extra cushion. I go for a minimum of 30 cents credit. On a $5 spread that is a .30/4.70 reward to risk ratio, or 6% in a month (or less -- you can frequently get a decent credit on a position with less than two weeks to expiration). That may not seem like much, but of course you don't have to let the position lose all the $470 at risk!
Please remember to use sound position management. And the second point to remember: the success rate is much higher than with many other types of strategies because of that "two ways to win" feature. My own success rate has been about 75% in the six months I have been employing this strategy (I'm still learning!).
If, like me, you are a conservative trader who likes to "hit a lot of singles," or someone looking to finance some bigger plays from some moderate but pretty steady income, I think you will be pleasantly surprised by how well OTM put credits can fill the bill.
Eat My Theta!
As an avid options trader for a little over 2 years now, I’m a huge fan of credit spreads.
I started out trading call options, looking for the big pop, and hit several. Its pretty exhilarating to make $10,000 in 2 hours on a Monday morning.
But one bad day in September 2008 I lost $20,000 in the same amount of time, and decided the roller coaster wasn’t quite as much fun as it used to be.
I had known about credit spreads and iron condors for some time but never traded them so I did some more homework and started working them.
I only trade short term (2mos out or less) OTM put spreads on stocks I really like. Its like selling an insurance policy to someone, then reinsuring a portion, thereby limiting my risk.
The reason I love them is because I get cash up front, and every day that goes by, they become a little more valuable. Someone else gets to “Eat My Theta!”
(Maybe I should make a T-shirt with that saying. My wife and her sorority friends probably wouldn’t think its as funny as I do!)
The last thing I like about them is they make me feel smart. After all they are fairly sophisticated option strategies, that are not for the ordinary investor.
Having traded dozens of these over the past several months, I have had only one go bad on me. As the stock price approached my short put, I panicked and started adding trades to try and protect my position.
After creating a real mess, I ended up losing more than if I had just taken my lumps on the initial trade. That’s the good news.
The bad news is that I really haven’t learned how to adjust the trade if needed. I figure necessity is the mother of invention, so I’ll figure it out when I need to.
Credit spreads are great tools, and the monthly cash flow has saved my a$$ in a bad real estate/oil and gas environment.
Watch
Out for the Effects of Hopium
The bull put credit spread started out like all the other ones, without much fanfare and looking pretty secure. The stock was stable at 145. With a week to go before expiry, I sold the 130 put and bought the 125 put for a net credit of 35 cents. Surely, the stock wouldn't go down by 15 points in a week. Famous last words.
Over the next week, the stock drifted down.. On Thursday before expiry, the stock had dropped down to 129.98 but closed at 130.42. Hmm, 42 cents out of the money and apparently going up. Now what? What should I do? Wait and hope that the short option stays out of the money? Or enter an order to close the spread and lose the credit that I received? I was like a deer, frozen in the headlights. I was hoping for the best, not realizing that I was coming under the influence of the dreaded hopium.
On top of that, I would be away on Friday, with no internet access to my broker and limited telephone access to get quotes or enter orders. What a quandry. I would sleep on it.
Friday arrived and in the morning I did nothing. At 11:30, I called for a quote; the stock was down to 127. But it might still go back up. More hopium.
By 2:30, the stock was down to 123 and both strikes were in the money. Snap out of it! Close the spread regardless of cost! With the stock at 122.48, I closed for a debit of $4.89. At least it wasn't the full $5.00. The original credit of 35 cents provided scant relief, but I was out of the position.
Only later that night, as I was asleep and dreaming, did I figure it out. The dream hit so hard that I awoke. Of course! I should have used a contingent order to close the spread!!! I used them before, but completely forgot about them. The hopium must have made me forget.
Now, I manage my credit spreads more carefully. Near expiry, I use contingent orders to avoid getting burned by sharp moves in the underlying stock. And I watch out for the effects of hopium.
Even After a Disaster I Still Trade Credit
Spreads
First of all let me say what a neat and original way to promote a new product. This alone will ensure I read your emails more carefully in the future. Second, if I do win a prize, please don't tell my 9th grade English teacher. It will surely give her a heart attack to know that my essay writing actually won something.
I have been trading options for about six years and in all that time I have traded credit spreads as my main trade. I live Brisbane, Australia, and for us, when the US is on daylight saving time, the US stock market opens at 11.30 at night and closes at 6 am the following morning, so I can get up early in the morning and see how much money I have made (or lost) overnight.
I love credit spreads. There are three main factors that determine an option price - time, underlying price and volatility. With OTM credit spreads you have two of those factors on your side every time and possibly the third if you select wisely.
Time: every day that passes, if the underlying price stays the same, the value of your credit spread increases.
Underlying Price: with an OTM credit spread the underlying price can stay the same, move in one direction a lot or move in the other direction a little and you can still make money.
Volatility: If you can put on a credit when volatility is high, as the volatility drops you make money. So with a credit spread you can stack the three main factors of an option price in your favour and that makes credit spreads the neatest trade in my book.
You ask about my greatest victory, but none come to mind. I think it's because there have been so many. I usually set up credits spreads with a 20% return and that gives me about an 80% chance of success and so most of the time my credit spreads just expire worthless and my trading account just notches up a little more - month after month.
Now my greatest disaster or 'learning experience' as you call it. That is permanently etched into my mind and trading account balance. It was the Thursday before expiration Friday of September 2008. I had a few credit spreads on the RUT. As you know the RUT is an AM settled index which means that the Thursday before expiration Friday is the last time you can trade these options. The settlement price (RLS) is determined when all 2000 of the stocks that make up this index open on Friday.
I had a 730/740 call credit spread and the market was going down. I had to leave home early that morning and so I checked the market about an hour before it closed. The RUT was trading around 680 and going down. I had my stop set at 730 and all looked well.
I check the market when I got home later on that day. The RUT had shot up and closed at 723, too low for my stop but too close for comfort. There was nothing I could do. and you guessed it. Expiration Friday the RUT opened at 743. The RLS was even higher.
I lost US$40,000.00 that day and at that time the Australian dollar was worth sixty US cents so you do the math.
I can't, it's too painful.
Even after that experience I still trade credit spreads. I closed one on the RUT last week (on the Thursday) and made just over $2000.00. I would like to learn how to make them more effective and, if possible, how to adjust them.
Thank for this opportunity to write about credit spreads.
Stacking the Odds in Your Favor is
the Name of This Game
My experience with credit goes way back to the good ol’ days with “Uncle” Wade Cook. As you may recall, he was a champion for spreads and covered calls.
Credit spreads excited my greed because I liked the “ka-ching” into my account the very next day. Seemed like instant money to me and a very nice concept. But I soon discovered that there is a characteristic with this type of spread – easy come easy go. Also a margin in your account has to cover the event that the spread may backfire on you. The margin also limits a trader’s ability to put on many positions at one time if the trading account is small.
My initial excitement got quenched a bit when I discovered that one bad credit spread that went sour could wipe out, virtually clobber, a bunch of profits from prior successes. Of course, “stops” were not part of my agenda at the beginning. In contrast, if things went smoothly the regular cash flow paid off some of those nasty monthly bills. It was indeed a bumpy road during my early learning experience.
However, I learned along the way that there are some bright spots about credit spreads that kept me going. One is the slight departure from the plain vanilla credit spread to the “Iron Condor”. I put on both a Bull Put and a Bear Call spread at the same time, hoping the underlying would expire somewhere in the middle.
Also this technique generated more credit into my account.
Eureka I shouted, when it dawned on me that the underlying can never be ITM at both spreads at the same time. But I also quickly discovered that the additional commissions paid out are not pleasant.
Experience has shown me that to become a good credit spread trader requires use of technical analysis (TA) along with a bit of fundamentals. TA would include finding an underlying vehicle, whether a stock, indice or an ETF that is launching off SOLID support or resistance.
Stacking the odds in your favor is the name of this game.
Speaking of odds, another attraction to credit spreads is the fact that they are a non-directional trade. The underlying can go up, go down, or stay the same and you can still come out a winner!
In addition, volatility and delta play helping roles in collecting bigger credits on those front month options.
In the interest of brevity, I must come to my conclusion on this essay. I remember during the early days as a subscriber to Cash Flow Heaven the trading focus was definitely on playing credit spreads. I noticed the focus gradually shifted to directional trading - buying calls and/or puts. You can make much more money but the credit "ka-ching" is gone.
Can it be that the credit spread is making a come back? Having more “options” to choose from in the Cash Flow Heaven trading arsenal is something I look forward to.
The Thing I
Absolutely Love About Credit Spreads
I have been trading actively for the past 7 months on my journey to turn this passion into a full-time occupation. I started with straight stock trading using various methodologies but all using technical analysis and have learned a ton along the way (and also realize that I've really only scratched the surface!).
About 4 months ago I decided to explore
options as I had only a very rudimentary
understanding of them but was attracted by the risk
management and leverage they provided. I have been
studying options for the past 4 months intensively
and really trying to dive into the details of the
pricing models, option strategies, and the market.
I've also been adding them into my trading arsenal
until now I almost exclusively focus on equity
option strategies.
Right now I am focusing mostly on straight call and
put buys and Credit Spreads.
The thing I absolutely LOVE about Credit Spreads is that I'm actually making the odds work for me rather than trying to defy them. What better way to trade than to set the gauntlet down and challenge the market to beat me as opposed having to figure out how to beat the market?
This thinking really sits well with my personal psychology. And the ability to manage and/or morph the trade when things don't go in my favor really makes for even greater flexibility in my trading and (I think) increases my odds of profiting consistently. At the end of the day, that's what I'm looking for - consistent profits month after month!
I am still learning how best to
manage adjustments but am very excited about the
possibilities.
My greatest victory so far with Credit Spreads was
also my greatest learning experience and oddly
enough was the first Credit Spread loss I took this
past month.
I had already placed this particular trade before I instituted my rule of having the short strike at least 1 Standard Deviation from the stock price and the stock started moving against me. I carefully watched key resistance levels and the stock's reaction to the overall market as well as my hard stop loss point and ultimately pulled out of the trade with a minimal loss.
All of my key
trigger points had been violated and so I acted.
The stock ultimately ended up turning back around
and moved in my direction, but I was so satisfied
with how I followed my trading plan that I was not
upset at all. In fact that experience provided
further validation that Credit Spreads (and income
generating option strategies) are superior
strategies for my psychology and risk tolerance.
With my limited experience, I've learned many
lessons already, but a few things particularly stick
out that are probably already obvious to more
seasoned traders.
First, never place a trade when earnings will be announced before expiration.
Second, set the short strike at least 1 Standard Deviation from the current price and ideally at a key resistance/support point.
Third, have a plan
for exactly what you are going to do whichever way
the underlying stock moves before you ever put on
the trade.
I'm very excited about the possibilities of Credit
Spreads and other option income strategies that put
the odds in your favor and look forward to the
credit spread package you're putting together.
Thank you also for making the Options Success
service available. I've found it a fantastic value
and really appreciate Pete's daily summaries and
recommendations.
And last but definitely not least...
Pump that Nickel
I first came across credit spreads one lunch hour when I felt a "hankering" for something new on my pumpernickel bread. Now having some strong Germanic lines in my ancestry, I have to admit that I can't pass up a good Pumpernickel, unless of course you're talking about the only kind of sourdough bread worth harping about: San Francisco Sourdough Bread (notice the capitalization given for respect).
As
Billy Crystal, In Princess Bride (one of my top 5
all-time recommended films), swooned about a good MLT (Mutton, Lettuce, & Tomato) sandwich, I have
come to swoon over a good credit spread on
Pumpernickel.
My greatest victory with credit spreads has been
convincing my wife NOT to put it on store-bought
white "air bread", but rather on, you guessed it,
Pumpernickel. It doesn't even need mayo or cheese.
Whatcha got to watch out for are the scammers who
will sell you false credit spreads with bogus
ingredients, which amount to nothing more than debit
spreads dressed up with garlic and mayo.
Lately, I've made more money on my bearish call
spreads because I've found more small cap stocks
that were overbought and were getting stagnant and
stale (again, it's that store-bought air bread or
cheap pumpernickel - not good enough to merit a
capital P).
So, in summary, my advice is : buy the highest
quality, freshest credit spread you can find, and
serve it up on real Pumpernickel from your local
bakery.
Fabulous job one and all--Thank you!
