Lecture Notes: Trading Credit Spreads
Introduction
- Speaker: Dan Pasarelli
- Topic: How to trade credit spreads
What are Credit Spreads?
- Credit spreads involve selling one option and buying another of a different strike price with the same expiration.
- Types of credit spreads:
- Call Credit Spread: Sell a call and buy a higher strike call.
- Put Credit Spread: Sell a put and buy a lower strike put.
- Credit spreads are used to limit risk while profiting from options.
Why Trade Spreads?
- Risk Management: Shape risk rather than a binary outcome.
- Hedging: Protect and control capital expenditure and portfolio.
- Leverage: Achieve a greater percent profit with lower dollar amount losses.
- Profit from Time Decay: Options lose value over time, benefiting the seller.
Mechanics of Credit Spreads
- Call Credit Spread: Use cases
- Profit from low volatility and time decay.
- Adopt a "not bullish" stance on stock.
- Put Credit Spread: Use cases
- Profit from time decay in low volatility environments.
- Adopt a "not bearish" stance.
Setting Up Credit Spreads
- Time Frame: Set up between 1 week to 2 months to expiration.
- Strike Price Selection:
- Call Credit Spread: Sell strike at or above resistance.
- Put Credit Spread: Sell strike at or below support.
- Probability & Risk:
- Calculate maximum gain and loss.
- Consider high probability trades and use out of the money spreads for more success.
Strategies and Considerations
- Out of the Money vs At the Money Spreads
- Out of the Money: Higher success rate but lower payoff.
- At the Money: Greater payoff but lower success rate, used for more directional trades.
- Technical Analysis: Utilize support and resistance levels to guide trades.
- Volatility and Market Conditions: Avoid entering trades during earnings announcements or major market news.
Additional Insights
- Trade Management:
- Know your max profit and max loss before entering.
- Use shorter-term expiration for better predictability.
- Exit Strategies:
- Take profits at 50-65% of maximum potential.
- Roll positions to adjust losing trades.
- Greeks Consideration: Understand gamma and theta impacts near expiration.
Q&A Highlights
- Use iv percentile to identify overpriced options.
- Adjust losing trades by rolling them to less risky positions.
- Opt for shorter-term expirations for more consistent outcomes.
Conclusion
- Key Takeaway: Use credit spreads to manage risk and profit from low volatility and time decay.
- Encouragement to practice and refine strategies.
Remember that credit spreads are a strategic way to trade options with a focus on controlling risk and leveraging market conditions. Always be aware of the market environment and apply the strategies accordingly for better outcomes.