High Probability Credit Spread

There are two ways to trade credit spreads, well to be honest there are many ways to trade credit spreads; however there are two basic option strategies. On is the low capital risk trade and the other is the high probability trade. The high probability trade is the one I recommend to most beginning option traders. The reason is that when the market moves against your trade you have time and space to get out of your trade or somehow adjust your trade before you have a major loss. Lets give an example of a high probability credit spread option trade.

The high probability credit spread trade consists of creating a trade using out of the money (OTM) options to compose a credit. Lets use an example of a stock trading at $55 that you feel is bearish, feeling it will fall and stay below $50. We can create a credit spread by selling an OTM $65 Call for $1.10 and buying an OTM $70 Call for $.50 creating a credit of $.60. The max value this is $5 (the difference between the strike prices) which makes your risk $4.40 ($5.00-$0.60). This makes for a high capital risk making only $0.60 while risking $4.40 or a 13% rate of return. However the probability of the trade being successful is much greater because already the stock has to move up 10 points just to reach your sold option. As it stands, the stock will need to close below $60 at expiration of the options and since it already is below $60 and you feel the stock is weak and will be going lower. The probability of it gaining 10 points or 18% is unlikely. In comparison to a low capital risk trade using at the money and in the money options to make the credit spread, the stock already being at 55 would have to to fall 5 points and stay below $50 for a low capital risk trade to be successful. This is what makes this credit spread a high probability of success and the preferred choice for beginning option traders.

To learn how to trade options in this manner, go to Conservative Options and check out the book How to Trade Conservative Credit Spreads