October 3, 2010
I Loved Trading Option Credit Spreads Until…
The truth on trading “credit spreads”…You will learn why it is so important if you do not know how to correctly handle your option positions. Even though it is a well known trade we will take a good look at what can happen using this particular spread. This seems to be a good trade, but until you work with this trade, you will not know the high risk it can be. If it is traded alone this options “credit spread” can be very risky. By trading it alone I mean that it is not being protected by another option trade.
The first spread learned by most beginning option traders is the credit spread. It’s a very simple strategy, but what many beginning option traders do not know is that this particular strategy can be very dangerous. There are many courses on the internet that teach this strategy, but the reason is not because it’s a great strategy, but rather, it’s simple, and it’s easy to sell. What I mean to say is that teaching credit spreads to beginning option traders is simply a great business, but the fact is, many option traders who only trade credit spreads lose a lot of money each year. Not only do they lose a lot of money, but it’s also a very stressful way to live. Let me explain why.
It’s well known that an option trader can enter into a credit spread with a 90% probability that he will make money on the trade. That is well known. That is the popular belief, especially amongst beginning option traders. This is true, but do not ignore the other side of the picture. Even though you have a 90% probability to make a profit on the trade, you must consider what goes on while the trade is in play. People don’t talk about the level of stress involved.
Sometimes they are behind the whole time they are in the trade, but they do not tell you that. They don’t talk about how they feel, how worried they are right to the last day and how difficult it is to sleep at night, and praying to God for their stock to go up tomorrow. They are risking 90% just to make a small 10% profit. Finally, the sad truth is you may lose 90% on your first trade, and what no one tells you about the credit spread is that a 90% probability doesn’t mean that you are going to make money nine times in a row and then lose one time. You might be the unlucky one who loses it all on the first trade. This does happen often to beginning option traders.
The “credit spread” is a very directional trade and this is the problem. Even though it has Theta on its side, it has Delta and Gamma working against it. For the little amount of Theta that you get from a credit spread, you are picking up more danger by trading this option spread with very high Gamma, because when the prices of the underlying changes, the profit and loss on the trade will also change very fast. This type of trade is a lot more volatile and high risk than most beginning option traders are aware of.
In ending this class on the high risk in “credit spreads”, I would just like to say that there are many other types of trades that are much safer than this “option spread”. If you do trade “credit spreads”, please try to combine them with other trades so they are not so risky.
Learn more about low-risk Option Trading. Stop by San Jose Options Mentoring where you can find out all about Broken Wing Butterflies and Credit Spreads.
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