Transcript for:
Understanding and Trading Credit Spreads

welcome everyone uh how are you today my name is dan pasarelli and uh i am going to be your host for the next hour or so [Music] if you can hear me make your way on into the chat box oh wait apparently now i can start my video and give me a big old yes there we go okay great all of the technical difficulties have been fixed yay accepted i'm on the run i'm on the last slide there we go okay you guys can hear me that's awesome so my name is dan passarelli and today we're going to talk about how to trade credit spreads credit spreads are one of my favorite strategies uh it's definitely one one of the go-to strategies when i'm looking at a particular stock or etf and um the beard is longer than it was but not really new uh so yeah credit spreads are one of my favorite strategies to trade when uh when i'm looking at stocks and certain criteria are met and i'm going to share with you what all those criteria are in just one minute before we get started i need to point out options are not for everyone and you should read characteristics and risks of standardized options before trading okay so excuse me one second here okay so we're talking about spreads so let's let's kind of look at the mile high view for just a second here why would we trade a spread instead of just buying a call or something well the reason we use options in general is to what what a lot of professionals would call shape your risk right if i just buy a stock then if it goes up i make money if it goes down i lose money and um you know i i've sort of got this pretty binary sort of bet on right but when i use options i can i can control my risk i can hedge and protect my portfolio or or even a stock on an individual trade i can lower my capital expenditure on a trade i can trade what is called option centric risk meaning i can make money from time passing or if implied volatility changes i can even take on leverage i can get a greater percent profit when um you know when the trade goes my way and at the same time i can also have lower dollar amount losses now one of the things that we do when it comes to spreading is we use spreads in order to sell options on a less risky way because look when we sell options here's what we want to do we want to we want to we're selling them because we think that in the future they'll become worth less so we sell them at whatever price we can sell them now with the objective to buy them back for less later and one of the ways we profit when we sell options is by collecting time decay as time passes options lose their value and so when we're short them that's one thing that's sort of on our side the risk can be unlimited when we sell options naked and that's a problem even though time decay works through the trade if there's a big enough move against us it can be trouble so the solution one of the solutions becomes credit spreads and there are two types of credit spreads call credit spreads and put credit spreads a call credit spread is when we sell a call and then we buy a higher strike call with the same expiration on the same underline a put credit spread is when we sell a put and then we buy a lower strike put further out of the money with the same expiration on the same underline so before we go any further i feel like the best way to think about credit spreads is this the short option is the trade that is where you're making whoops the short option is the trade that is where you're making or losing your money the long option is just the insurance okay so if you think about it that way you're gonna get a lot more clear picture of what it is you're trying to accomplish all right so let's let's break both of these trades down we'll start with the call credit spread why would we use a call credit spread well because we want to profit from low volatility right typically in a particular direction in this case we want to profit from the stock not rising very much we'll talk more about that in a second we want to profit from time passing while the stock is experiencing little volatility and we want to do it in a limited risk sort of way now when do we use this when we're not bullish so i'm not necessarily saying bearish i'm saying we have a not bullish stance okay maybe we put those in in air quotes we can do that with video air quotes a not bullish stance basically we just think that the stock is not going to go up above a certain price typically technically what we look for is we look for a stock that has resistance on the chart maybe it also has reports excuse me maybe it also has support and it's in a channel but it's near the top of that channel a little bit closer to resistance uh also as far as fundamentals go there's either maybe some mildly bearish news or no news at all okay like basically if if you're watching like one of the top business shows right maybe you're watching tony on cnbc chances are if if he and and his uh fellow pundits or whatever you want to call them are if they're talking about a stock it's probably actually not a good candidate for a call credit spread most of the time tony's a little bit more sophisticated so maybe in his case it is but you know there's not they're not these high flyers they're not ones with these big things going on and big news good or bad they're they're kind of these boring old stocks so i've got some guidelines and if you're taking notes you should write this down you want to know your maximum gain and your maximum loss and i'm going to show you how to easily calculate those things we want a high probability trade which most of the time these will be we'll talk more about that on the next slide we typically want to set these up between one week to expiration to two months to expiration i have set them up with less time uh but a lot of times it's it's hard to find trades with less than a week to expiration you can sometimes um going out more than two months until expiration is usually not ideal because usually you could sell a shorter term credit spread and take in and get a higher theta therefore make more instead of selling one three month credit spread you could sell three one month credit spreads [Music] we also like i said we're not looking for a stock that has a lot going on if earnings is coming out we're not going to do this or even if any other news is coming out if there's a fed meeting and we're talking about the spy we're probably not going to trade a credit spread on it call or put now it's common to trade credit spreads and again we're going to focus on the call credit spread here first one of two ways we could trade out of the money called credit spreads or or at the money call credit spreads so an out of the money credit spread has a higher chance of success than an at the money credit spread it's further away so you're going to get a lower credit received which means a smaller payoff when the trade works out but a bigger loss when it doesn't and at the money spread where where we sell one call that's basically at money and then buy one that's somewhat out of the money has a lower chance of success than an out of the money spread and in fact we need not just a not bullish stance but but we would do that on stocks that were somewhat bearish on actually we get a greater credit received which means a bigger payoff when the trade works out and the other side of that is we have a smaller loss when the trade doesn't work out compared to the totally out of the money spread okay so let's take a look at exactly what we're talking about here let's say we have a stock that's trading at 59 a share and there's resistance at sixty dollars a share and maybe this stock is kind of flirted with resistance and maybe touch 60 or something and it kind of bounced a little bit back down looks like it's not going to go above 60. okay well here's one thing we could do we could sell the i have nov here on the slide november uh as the example but remember whatever month you're watching this uh recording we typically don't want to go beyond two months until expiration so in this case we would sell the november 60 call at four dollars and then at the same time buy one of the november 65 calls at two dollars and twenty cents okay so we're selling one of these calls at four dollars a share and buying the other one at 220 a share so we collect four dollars we pay 220 we're collecting a net credit of a dollar eighty now that's a dollar eighty to share with options listed on the u.s exchanges anyway [Music] each option represents a hundred shares of the underlying stock and so in that case uh that would be i would take in literally a hundred and eighty dollars now there's another thing of note here and that is you may have noticed that where i'm saying we observe resistance at sixty dollars a share we're selling our strike at sixty that's no coincidence when we do call credit spreads we get an edge by selling the strike at or above resistance and then buying a higher strike now why is that an edge well because look when we trade options we can make money by direction you're well let's say by the stock price movement by time passing and by volatility so if sixty dollars a share is the price that the stock has gotten up to and then bounced down below in the past then maybe that resistance will hole what me and my other coach john here uh have identified is that resistance tends to hold okay it doesn't always hold but more often than not it does so that's one extra thing that's on our side this little you know bounce it's uh it's kind of like when you uh remember when you were a kid and you would go bumper bowling because you know you didn't have the fine motor skills of like keeping it on the lane and out of the gutter so they put like bumpers in the gutters you guys anybody ever played bumper bowling super fun it's a lot easier right well if the ball gets too close to the gutter the bumper just sort of bumps it back into the lane that's kind of what resistance and and for that matter support are for stocks right now obviously if you're really bad and you throw the ball really hard it can bounce over that bumper and you know stacks can go through sport and resistance but um fun little analogy that just popped into my head so a couple really important things here i told you before that it's very important to understand your maximum profit maximum potential profit and your maximum potential loss so the maximum profit the most that can be made by trading this spread is a hundred and eighty dollars or a dollar eighty per share why is that let's just think about it well we sell these options we collect a dollar eighty and if the stock ends up staying below in fact here let's go to the next slide if the stock ends up staying below 60 dollars a share and ad expiration is still below 60 a share all those options would expire and the 180 dollars that i collected is mine to keep so that's why that would be our maximum profit now just looking at this this graph here what do you think the worst thing is that can happen well what if the stock goes up above 65 a share and is trading there at expiration well that's the worst case scenario why because the 60 call that were short would get assigned and i would have to short stock at sixty dollars a share and if it's above sixty five dollars a share i would exercise that 65 strike call and therefore buy that stock back that i sold at 60 at 65 locking in a loss of 5 but mind you i collected a dollar eighty a share so the net loss is just three dollars and twenty cents that's the most i can possibly lose on this trade unless i try really hard to screw it up uh now our break even is 61.80 and the same logic sort of follows if the stock is above 60 but below 65 i would get assigned on the 60 call therefore getting short stock at 60 a share but i p and l that dollar 80 i collected so my effective short price would be 61 and 80 cents the way to mathematically calculate the maximum loss like you know the max gain is always just what you collect the way to calculate the max loss is just simply the difference between the two strike prices which is easily identifiable here it's five bucks minus the premium collected so five minus 1.80 is 320. now let's talk about the put credit spread this is this is like pretty easy right like are you getting this hit the chat box and give me a big old yes if you're getting this yes jerry says yes and herb says yes victor corey russ david no no no is your first name and your last name that's a funny name uh dylan siva michael tom all right jim carlos eva ken it's hard to read all these names going across here ralph good you guys are awesome so guess what the put credit spread is just as easy it's basically the call credit spread but for the opposite scenario we use it because we believe that there will be a low volatility environment particularly maybe sort of drifting a little higher or at least not going down we want to profit from time decay with limited risk so we use that with a let's do the air quotes again not bearish stance okay not necessarily bullish but not bearish we have support here or maybe we're near the bottom of a channel bouncing off support if there's any news it would be mildly bullish or just simply no news at all so here we always want to know our max gain and our max loss we want a high probability trade which this will be if we set it up properly we'll talk more about that in a minute too run one week to two months time horizon until expiration when we put the trade on and we want no earnings or other news expected before the expiration of the options we're considering using murra says do i have the rules for the credit spreads yes i'm literally giving them to you right now that's what this presentation is about i've already done that for the call credit spread so now we're going to talk about the credit score okay so we can put on put credit spreads two ways as well one where all the options are out of the money and one where one of the option the option we're selling is at the money and when we're buying is out of the money now i want i i had basically the same slide here for the call credit spread and you might look at this like for those of you who trade call credit spreads like there's a couple of just fun little nuances that aren't in this presentation slides that i want to share with you so that you know even if you're experienced with this you're going to get something great out of this so over the last maybe six months or so i've been looking at uh unusual activity hello what the heck just happened here hold on a second here sorry about that i don't know i don't really even know how that happened but we're gonna fix it two me a big old yes if you can still see my screen [Music] give me a big old yes if you can still see my screen okay good okay uh so what i was saying unusual zoom activity yes ash yes [Music] so this is very interesting i've been studying unusual activity over the past six months and just look which basically means like looking at uh looking at like what has traded okay like hey 1200 of these puts 1200 of the april 50 puts traded at 63 cents and exactly 132 and 50 seconds and two hundredths of a second or whatever it is and i've been doing a scan that i created for credit spreads what's very interesting is is very counter-intuitive to those of you who have traded these before okay more credit spreads than not are at the money credit spreads where where we're selling the at the money option and then the out of the money option is the one that we're buying and that's pretty surprising for many years i've set up my credit spreads more out of the money looking at them as high probability trades and for those of you who use who look at delta as a proxy it's really just an estimation it's not mathematically accurate but for those whose who use proxy as or those of you who use delta as a proxy for probability of success like the further out of the money you go the the greater your chances of success so i always looked at it like that just a super high probability trade but i would say most of the credit spreads that i see trading they're selling the at the money option it's a little bit more of a directional trade so that's why like i actually had this slide in the presentation i've given this presentation a good handful of times in the past i've had this slide in there for years but i only recently came to the realization that a lot of people maybe more people do bullet point too here the aftermath spread interesting isn't it i'm i was surprised by that when i started seeing that so anyway with put credit spreads it's sort of the same thing here if we sell two out of the money options we have a higher chance of success because because if the stock goes up i make money if it stays where it is i make money if it goes down a little bit all the way to the strike price but not through it i still make money now they're further out of the money options so i receive a lower credit which means a smaller payoff when the trade works out and as you saw how to calculate the um the maximum loss it's the same with puts the difference between the strike price minus the credit received so that means if i if i receive a smaller credit my maximum loss is bigger so in in a lot of ways the out of the money trade like i could pose the question here and it would be pretty interesting to get some answers is which of these is is more risky and it depends how you think about risk right the out of the money one has a greater chance of success you'll you'll like if you run permutations or if you trade spreads like that a thousand times you'll you mathematically should make money on a lot more of them than you lose whereas the at the money is more risky in that regard because it's a lot more fifty fifty but if you look at it from a risk reward standpoint even though the out of the money spread is a higher chance of success your profit is much smaller and your loss is much bigger so they're they're almost like different types of trades all together out of the money credit spreads and at the money credit spreads um i do like to hold all questions until the end so that i don't get distracted but uh and and so i'm gonna do that wayne you're hold that question and and fire it back at me later uh uh all you guys okay i don't like for me to get distracted because that you know that could be annoying to you but i i did leave plenty of time for q a so uh we're gonna get to all your questions that's my favorite part you're still i hope so here's an example let's say you know i'm mildly bullish on a 66 dollar stock right or maybe i'm not bullish at all but there's just really strong support at 65 a share okay the past five times it hit 65 it's bounced higher now another thing here support or resistance for that matter they're not just like these magic lines on a chart that oh look the stock bounced off okay whoop-dee-doo big deal like they actually mean something technical analysis in general is a map of human behavior it's what happened it's it's a map of the orders right if a stock every time it gets down to 65 it bounces higher why does it bounce higher why would a stock go up in fact there's only one answer to this when we're on the trading floor and we talk about this like i felt like i was being a a smart aleck every time i i said this but why would a stock go up what is the only reason why stock goes up who can tell me we've got a good number of folks in the room here somebody's going to fire off that answer right now in the chat box more demand than supply bingo good job edmund it's demand pressure it's buyers says jim too right exactly mike will volume but but specifically buying volume right demand exactly because like if there's you know 300 shares offered at at 61 and somebody buys 300 shares they're not offered at 61 anymore the offer is higher and then the bid ends up being higher too it's just the it's just the uh it's just the um mechanics of the market and and yeah so uh dovel says tech analysis is astrology for traders and a lot of people feel that way and and to be fair maybe some of it is especially for some traders who maybe look at all these like really kooky things but like this stuff like the the basics of technical analysis is not astrology and that's what i'm trying to say here like there are many like value traders right and i'm not saying like like a regular retail trader like many of the folks who might be attending this webinar i'm saying like a big institutional trader with like hundreds of millions or a billion dollars like in the fund right who hires these quants for a million dollars a year to run these models to to tell him or her where what the value of that stock is right there's lots of people like this and when that's and when that stock goes too far down below value right that's when they buy it and they they just set uh like a target or an alert or whatever it is on their computers and they say oh it went to 65 that's you know 20 20 below our value range that our you know brilliant genius quants told us you know that is where we should buy because it's extremely cheap at that level like that's what a support line is it's really not something magic or like you know self-fulfilling prophecy or or like you know like dole said you know astrology you know like there's a lot of technical things that really mean something and support and resistance like they're the kings of like that's extremely useful information so how do we as not quants how do we as not billion dollar institutional traders how do we use that information it's almost like we can make the quant or the institutional trader work for us because we know that if there's enough buying volume somebody added volume to that and i and i like that if there's enough demand pressure buying volume at this price because there's obviously in hindsight there's obviously people willing to put big money behind buying it there maybe they'll be running that same model this week right you probably will [Music] and so that puts this extra thing on our side it's it's almost like we're like we're like glimpsing just a little bit like a little peek through the blinds of this quants office kind of right we're getting just a little bit of this information like ah this is one thing that's working for me on my side to put me ahead of statistics and selling volume you know that's the resistance line ken yeah yeah okay so here we sell the november 65 put which happens to go coincide with where i'm saying support is in this case we could sell it at support we can sell the strike price at support or below support and then we buy a lower strike put which one is the trade and which one is insurance 65 put because that's one we're selling is the trade 60 put is the insurance the maximum gain here is 1.60 maximum loss the difference between the two strike prices minus the premium received so five minus a dollar sixty is three forty and the break even here is just simply 65 minus a dollar sixty so that's 63.40 now i want to point out yet another thing here that's not even on the slide just another thing i mean is that okay with you guys if i share like a couple of little nuggets that are not even supposed to be in the presentation but like i share a little extra is that okay give me a give me a yes if that's okay how did i know you were gonna say that it's almost surprising okay all right so so this is something that i think is pretty interesting here right i have had people say well why would i sell a put credit spread where i can only make a dollar sixty when i could just sell the 65 put and i could make 270 it's like almost twice as much and you know maybe 80 percent more or whatever that math comes out to i'm limiting my profits if i sell a spread instead of just the outright put you ever hear somebody say that you ever think that to yourself and sometimes it feels that way too but here's the thing what if i sold two of these spreads i could make 230. i could make more than just selling the put and there we go murrah hits it right on the head great job a couple other people chimed in the same thing recipe for disaster exactly we have unlimited risk with the put right so we have protection and if we sell two of the spreads instead of one put we can actually make more and potentially lose less now that's not 100 universally true because you know if we look at this if the stock ended up right at 60 if we sold two we could lose 640 right whereas just by selling the put we would lose a little bit less at this point but you know down at 55 at 50 at 45 we've got so much protection with this and that's why like before when i was saying about like we want low volatility here's another thing the most we can make is a dollar sixty i call this a not bearish trade as opposed to a bullish trade right it does have a positive delta we can talk more about the greeks later i saw somebody ask a question about the greeks i i want to get to all of them i might ask you to ask them again but just hold off i believe the next slide is actually your q a so just sit tight for one second so this is interesting the most here we can make is a dollar sixty we've a positive delta is this a bullish trade i mean we look here the higher the stock goes we have a profit but if the stock goes to 65 we make a dollar sixty if it goes to 70 we still only make a dollar 60. if it goes to 100 we still only make a dollar 60. so what this is really more for is it's for like you know low volatility if we think that this stock is going to explode up this is a terrible trade we'd much rather buy a call if we think that the stock you know it's going to follow a lot this is a terrible trade too it's better than just selling a put but it's not good so what did we just learn from that statement the credit spreads in general call or put are good for low volatility environments when we think the stock's not going to go up too much and we think it's not going to go down too much you know basically between the break even you know the stock is starting at 66 we want to stay above the break even but if it goes up a lot that doesn't really help us we want it to be somewhere within this sweet spot right here we thought it was going to go up a lot we'd buy a call and that would just you know that would be a whole different conversation i like dropping these little nuggets in there you know so that you guys can leave this presentation and like just put the stuff to use and really be able to like solidify and think about these things more clearly i love it i love it i love it um now you may ask by the way maybe somebody did i i was now looking at the questions dan dan that's me do you ever sell puts not part of spreads and that answer is yes i sell cash secured puts i don't sell naked quotes i sell cash secured puts and i only sell them in my ira i've got a couple on in there now in fact i've got i've got uh i believe it's in two different stocks in my ira i sold some cash secured puts and you know what happened the stocks had fallen below the strike price yeah now that's usually when most traders panic that's usually when most traders say well before traders do that they say yeah i would be okay getting assigned and then it falls below the strike price and they're going to get a sign and they say oh no this is terrible i'm going to get assigned i'm going to lose money but what i said before i put the trade on is not i'd be okay if i get assigned i said i hope i get assigned that's actually why i do cash secured goods because i want to get assigned and if the stock goes up and i skate and i get to keep the premium that's okay too but when it falls you know enough where i get assigned and i get to keep that premium it's like i can buy the stock you know it's like i was already thinking about buying the stock but i get to buy it at a lower price not just because the stock went down but because i also get to keep that premium so this is you know this is a very credit spreads are a very specific way you trade them when you have a very specific thesis on your trade low volatility i don't want to get a sign on anything i'm just trying i just believe it's going to stay above the strike price and i want to keep the premium okay now it's time for some questions which is my favorite part um and i'm going to work out like kind of from now so if i don't ask your question from before if i don't answer your question from before i might ask you to re-ask it so wayne says hey dan if we are at the money and getting closer to expiration why does our gamma increase causing bigger rapid delta changes well it's it's the math of the model like at the money options gammas and thetas get really big as you approach expiration on expiration day both gamma and theta are at their highest think of gamma as the price you pay for the benefit of theta think about it that way or you could think of theta as getting paid for bearing the risk of gamma they're opposites but they're they're more like two sides of the same coin so you know like why does gamma get bigger because it does i mean really like the way i think about it is because like at the money options are they have close to a 50 delta why because if you're right at the money it's like a 50 50 chance of whether you're gonna get assigned or not if you're right at the money and there's a year until expiration well sure there's a 50 50 chance but if you get in or out of the money by a buck or you know by five or even five percent or maybe even 10 the market can change courses so the deltas don't change that much but when it's like expiration day and you're right at the money you're a penny away from expiring in the money or expiring out of the money so so the gamma explodes because your delta is going to be your delta is not going to be 50 when the bell rings on expiration your delta's going to be 100 or it's going to be 50. it's like gamma to infinity right so i mean that's why it's like that interesting question wayne i like that novel says i put my put and call credit spreads at 20 delta on the short leg and do a 10 to 20 strike spread as soon as i make 50 or 60 i exit and place the next trade what do i think um there's a couple of some of the elements here i like and some uh i think are not as relevant i'm going to start out with uh the bad news okay so the way the option pricing model works is it basically ensures uh what's the word fairness it's fairness it's not really the perfect word but it ensures like sort of uh an equitable scenario it ensures that buying or selling in this case any one delta level is no better or worse than selling any other delta level meaning meaning if i sell you know if my method was to sell a 40 delta option and do a 10 to 20 strike spread and exit as soon as i make 50 or 60 percent my trades not better or worse than yours and that and that's because of this slide yeah if if i used a 20 delta that's an out of the money spread i have a much higher chance of success but my risk reward is a lot worse than a closer to the money spread right if i were doing a 40 delta i'd have more losers than with the 20 delta but i'm going to make more money on every trade and i'm going to lose less money on every trade so i like that part i i personally look at that as maybe just a perpetuated fallacy to me i would so much rather use support and resistance to set my strikes than the delta because the delta is arbitrary now as far as doing a 10 or 20 strike spread i mean it kind of depends on what the stock is right if it's a five dollar stock you know if you're selling a you know the five strike call and then buying the 25 strike call that's just kind of weird right um if we're talking about uh google pre-split or amazon let's just say um then if we talk about amazon then a ten dollar widespread is like a pretty tight spread right like it's really more in percentages i i think you know but you know if i'm just envisioning like a hundred and fifty dollar stock you know which maybe that's what you're talking about double okay makes sense uh exiting as soon as you make 50 or 60 percent i don't have a problem with that i mean what what i'll do on some of my trades is i'll exit maybe half at 50 and then try and get take a little bit more i never hold it all the way until expiration um i just think that at some point the risk reward isn't there if you have to wait a whole another week to make a nickel but if it reverses you lose you know 9.95 it gets a little silly then you know [Music] uh so yeah i i think that that that part taking profit of 50 or 60 is nice and conservative it's cool i like it yeah it's good jay says what are your rules for closing spreads and taking profits so there you go i mean i state that my rule is i close at 65 percent you know which is not far from what bill was saying but like i just said i will sometimes i will like if it's one lot you know i'll just close the whole thing at 65 sometimes if i want to be a little bit more conservative um you know i might go closer to 50 sometimes if it seems like a really good tree and it's working out i might be a little bit greedier uh sometimes you know i'll split it into into two orders i usually don't do three you know i usually don't like close some of it at 50 something at 60 some of it at 70. i usually split it up into two different uh exits corey says when a credit put spread is in the money both lags and close to expiration it's difficult to roll up and out for a credit is there a way to finesse it to get accepted ye uh well let's talk about that in a perfect world cory you start doing that role before both options are in the money for me my rule is and it's a very very simple rule and some folks who have been trading this a while probably have a different way of doing this or a different version but if if the stock crosses the short strike and the short strike becomes in the money that's where i either close the trade and take a loss or i might even be able to take a profit depending on how much time is passed or i do my role so i don't wait for both to get in the money i i do my role as soon as the short legs in the money and one of the reasons why i think it's difficult is because the when options are in the money the bid aspects tend to widen and sometimes it's hard to get get out of that trade even for parity um so yeah it which is another reason why when possible close it before that happens now obviously that's not always possible sometimes you wake up you go downstairs put your pod in the keurig come upstairs rub the sleep out of your eyes put it on your office glasses and you say log in your accounts and say oh my goodness what happened here how could the stock be oh no like all of a sudden this credit spread is working out so great now both legs are in the money you make enough trades that's gonna happen when that happens there's nothing you can do so the thing about difficult to roll up and out for a credit when you're in a situation where you have a losing trade ideally you'd like to do an adjustment to turn that losing trade into a winning trade but if you can't how about if you turn that losing trade into less of a losing trade that still works i mean if that's the only trade you ever make in your life then that sucks but if you're like a trader and you make a lot of trades throughout your trading career right and even if you're a retail trader you can still call it a career you can still call yourself a trader if between when you start trading make your first ever trade to 10 years 20 years later when you make your last ever trade if you make some of your losses smaller by adjusting you did great right so yeah don't don't feel bad about about a losing trade you you know if you make 10 000 trades i mean i guess my i probably made about 50 000 trades i made a lot of trades my days you know if you make 20 of that if you make 10 000 trades guess what you're gonna have some losers and it's okay it's all part of the game so yeah keep doing what you're doing but don't beat yourself up if if you can't just make it a win um can you on credit spread suggested uh what uh i'm not sure what that meant uh mark says do you have an exit strategy if the trade goes against you yeah we were just kind of talking about that um there's one of two things you can do one close down and take a loss and move on there is no shame in taking loss they say your first loss is your best loss because you take it fast and it's small and you're out and you move on to a better scenario whenever you have a loser you always want to make your money back but you know what you don't actually have to make it back on that same trade if the market changed and your forecast changed like you know like it looked like hey this stock is going to stay above 50 and then some brand new news comes out it might now warrant stock being above 50. your thesis might have changed close it take a loss and put that money to work on a trade that uh is better so yeah so that's thing one you can close and you can take a loss or you can you can do an adjustment if it's a put credit spread we would typically roll down to a lower strike if we're very close to an expiration we might have to also roll out to a longer term expiration we would only do that if there's more support below the trade the new trade has to also fit our criteria for being a good credit spread if it's a call credit spread we roll up to a higher strike if there's resistance and if we're too close to expiration we might also have to roll out to further out expiration [Music] good question where do you locate high option activity well i mean one thing you can just look on your brokerage platform and i i keep a column for volume and another one for open interest and it shows up there you can also look at time and sales i've got some uh fancy schmancy stuff that i'm still still working on for credit spreads not ready to roll out just yet but uh it's all sort of programmed um and i'm able to identify them but uh we don't have that available to the public just at this time how do you choose the strike and date for your cash covered puts i typically keep them pretty short term uh not always sometimes i have to go a little further out in time but i just i mean basically i mean there's a little bit of science behind it but basically i think where do i want to buy this stock so where's my target price what is the premium i can get and add the or i take the strike price minus the premium and if i get a sign that's why i would be buying it am i happy with that and if i skate if the stock doesn't get down and i don't get a sign is it worth is it worth doing for the that amount of premium that i'm going to collect usually most of the time like if you sell a a year-long put you usually don't like you would usually be better off selling like 12 one month puts than than one 12 month what um so i would have to do a whole presentation on on that and i could one day they're always asking me for topics so maybe next time michelle asked me i'll suggest uh i'll suggest that use the five dollar spread how do we decide on the spread so if you look like you always have different choices with your spread like if if all the strikes are in one dollar increments i go a dollar wide i can go two dollar wide i'd go three dollar wide four dollar riding five dollar wide but if if you ever compare those like next time you're thinking about doing a credit spread and the strikes are a dollar wide look at your your risk reward on the one dollar widespread on the two on the three on the four and out of five almost every time in fact i bet every single time you'll get better risk reward with the one dollar spread usually skip i i will skip a strike sometimes but nine times out of ten not skipping a strike ends up being a superior trait but check it out like it is situational you know so look into it like i said i don't always do sometimes i will skip a strike but usually it's a better trade if you don't [Music] what factors should one consider when determining the time frame to put on a credit spread so look if you are going to um throw a baseball at a target all right whatever your skill level is in throwing a baseball i think i probably don't have a lot of skill and that target is 10 feet away probably going to get it within this amount of a range right you're going to get it pretty close to that bullseye now if the target is 30 feet away are you still going to be within that same range no like it it's going to fan out you're gonna have much more margin for error 30 feet away than you would 10 feet away well guessing where a stock is going to be in the future is the same way so the shorter the amount of time to expiration the more likely you are to predict it right more likely you are to be right if your bet if you will it's not really a bet it's something different than betting trading is right but no let's just put it crudely like that if your bet is that the stock is not going to fall below 60 if that bet lasts one day or one year which are you more likely to be right on one day less can happen in one day so i like to keep them as short as i can and typically i make more in time decay selling shorter term options so you know probably you have a whole presentation on just that as well but short shorter is better all right i think i can take maybe two more questions here maybe you guys are asking some great questions do you always trade at the money or out of the money or mix it up what's the criteria used to identify um i tend to do more out of the money than at the money i do find that at the money is interesting because so many people do it but i've developed more skills for um out of the money spreads i think i just feel a little bit more comfortable with them let's see here when's the best time to exit a credit spread if the underlying stock moves quickly in your favor i do like to set it at a certain percentage i think i mean if i can if i put the trade on right now and it just really moves in my favor unex unexpectedly if i can buy it back for 65 of what i sold it i'll do it right now i look at it more that way not how much time has to happen how far the stock has to move what percentage i can buy it back meaning if i sell it at a dollar if i can take the most i can make is a dollar so 65 percent of that is if i can buy a back of 35 cents i'm going to do that i don't care if it's an hour later or three weeks later [Music] if your credit spread goes against then we have a three to one loss if you sell a put you get more credit and if it goes against we get put to us then we sell a cup yeah myron scholes prove that uh you can't you know that that game only goes so far at some points you just have such a string of bad luck that you run out of money is what happens to long-term capital a company he started but yeah yeah i mean bernard there's uh there's there's there's something to that for sure i like that a lot um i like it yep there's lots of different adjustments you can do will says nope where i already said that uh no i do not justin i do not target specific deltas that's mathematically mathematically speaking no one delta is better than another to sell that's just like how the how the option pricing model works uh darrell your girl's question is you open your short strike at the money with the 35 to 45 days to expiration within 5-10 days you go in the money do you give a timer get out as soon as as soon as it crosses the short strike i get out hey dan dan 2.0 here i like that thank you for doing this i'm relatively new to trading with a fast learner uh well there's a little bit of a lawn question it's about iron condors but i'm just going to make this easy for you think about daniel think about an iron condor as two credit spreads as a call credit spread and a put credit spread and what what i'll do is once i can take a profit on one of the credit spreads i'll do that a lot of the times in fact i'll always close it well not always most of the time i'll close it uh before expiration so just just like think about your iron condors as two different spreads and uh and you're in good shape and please get a reply got interrupted reply about what ken kevin i cannot i don't know what to reply uh okay i'm gonna take one more question then we gotta go oh john asks a great question do you use iv percentile as a factor yes so i'm glad you asked that because i get to drop one more like little nugget on you oh and i'm looking there's a few people who left class and they are not going to get this you guys put in the effort you put in the time you invested in yourselves by sticking around here the whole time and i love that and the folks who left early don't get to hear this so okay do i use iv percentile as a factor yes because here's what we're doing with this credit spread position it's true that if the spread goes in the money uh you know like if this if the stock moves against me i can lose money right and if it moves the other direction i can make money it's also true that if time passes i can make money and i will but there's also this volatility factor and the more i sell the spread for the better right and in fact when we're talking about different deltas like if we look at a a stock that's like well let's instead of using delta let's use a certain percentage out of the money okay similar concept different it's similar if if i if i'm looking to sell a spread three percent out of the money right so the stock is at a hundred i'm going to sell the 103 call and buy the 104 call okay if i can sell that call for 35 cents the most i can make is 35 cents most i can lose is 65 cents okay fair enough right what if those options were more expensive what if i could sell the spread for 45 cents then the most i could make is 45 cents i could make 10 cents more the most i could lose is 55 cents i could lose 10 cents less what we're talking about here is implied volatility implied volatility like i'm going to tell you the secret about implied volatility what it really is is how cheap or expensive options are you think about it that way you're going to be miles ahead of most traders it's how cheap or expensive options are so i really only want to put on credit spreads when i can sell them when they're overpriced when i can get a bigger premium all else held constant so like it's not just about direction it's not just about time but it's also like whenever i sell anything i want to sell it when it's worth when i'm selling it for more than it's worth right whenever i buy anything i want to buy it for less than it's worth right so yes use iv percentile absolutely as long as i'm making sure that like earnings isn't coming out or something like if that's why implied volatility is high i'm going to stay away but yeah great question john i love that okay that folks is all we have for today thank you so much for spending you your afternoon with me and i hope that this was super helpful and i'm gonna be back let's see i believe it's next week with another really really great really fun presentation you're gonna love it and uh i'm gonna see you then so mark your calendar uh i believe it's february 16th i'll be back all right trade well thank you catch you next time bye folks once again i'm dan pascarelli trade smart