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Traders Guide to Credit Spreads

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Traders Guide to Credit Spreads Trader’s Guide to Credit Spreads Options Money Maker, LLC Mark Dannenberg [email protected] www.OptionsMoneyMaker.com Trader’s Guide to Spreads About the Author Mark Dannenberg is an options industry veteran with over 25 years of experience trading the markets. Trading is a passion for Mark and in 2006 he began helping other traders learn how to profitably apply the disciplines he has created as a pattern for successful trading. His one-on-one coaching, seminars and webinars have helped hundreds of traders become successful and consistently profitable. Mark’s knowledge and years of experience as well as his passion for teaching make him a sought after speaker and presenter. Mark coaches traders using his personally designed intensive curriculum that, in real-time market conditions, teaches each client how to be an intelligent trader. His seminars have attracted as many as 500 people for a single day. Mark continues to develop new strategies that satisfy his objectives of simplicity and consistent profits. His attention to the success of his students, knowledge of management techniques and ability to turn most any trade into a profitable one has made him an investment education leader. This multi-faceted approach custom fits the learning needs and investment objectives of anyone looking to prosper in the volatile and unpredictable economic marketplace. Mark has a BA in Communications from Michigan State University. His mix of executive persona, outstanding teaching skills, and real-world investment experience offers a formula for success to those who engage his services. This document is the property of Options Money Maker, LLC and is furnished with the understanding that the information herein will not be reprinted, copied, photographed or otherwise duplicated either in whole or in part without written permission from Mark Dannenberg, Founder of Options Money Maker, LLC. This work has been created and provided as part of a paid service and is intended to be used by the person who is the registered client of Options Money Maker, LLC.. This work is protected by copyright. Page | 2 Copyright 2013, Options Money Maker, LLC Trader’s Guide to Spreads Introduction Congratulations! You have made a decision to invest in yourself by learning the art of profitable trading. The team at Options Money Maker is committed to your success! The strategies and ideas presented in this and each companion guide have been designed to provide you with a comprehensive program of learning. Our goal is to guide you through the learning experience so you may be an independent, educated, confident and successful trader. Trading can be exciting and extremely rewarding when done well. You will benefit from our years of experience and understanding of what works and what does not work. Financial media, the latest trends and most “expert” opinion will generally lose you money. We will show you the proper steps to achieve a level of profitable success that only 1% of traders ever achieve. There are numerous variations of traditional options strategies and each has a desired outcome. Some are very risky strategies and others require a considerable amount of time to find, execute and manage positions. The Options Money Maker team will show you how to devote a small amount of time each day to trading while realizing exceptional returns. Peace of mind is important to us so the training is designed to give you knowledge and confidence, both of which will give you the core skill set to be a successful trader. All of the strategies we teach are spread strategies and the ones covered in this guide are; Credit Spreads. You will see how this strategy can be successfully traded in any market condition. “If you don’t have time to do something right, when will you have time to do it over?” - Albert Einstein Page | 3 Copyright 2013, Options Money Maker, LLC Trader’s Guide to Spreads Spreads Spreads are simply an option trade that combines two options into one position. The two legs of one spread position could have different expiration dates and/or different strikes. Spreads 101 Spreads can be established as bearish or bullish positions. How the Credit Spreads are option spread is constructed will define whether it is bullish (rising bias) or trades that involve more than bearish (declining bias). one option. Different types of spreads can be used for the same directional bias of Stock movement and the stock. For example, if the stock has a declining bias, a call credit determine profit or loss. spread or a put debit spread could be opened to take advantage of the anticipated move down. Directional bias down – When traded properly, spreads are a limited risk strategy. Learning Call Credit Spread how to manage the risk is as important as learning the details of the strategy. Position management will be covered in the Trader’s Guide to Position Management. Directional bias up – Put Credit Spread Credit Spreads Credit Spreads – A credit spread is created when an investor simultaneously sells-to- STO OTM open (STO) one option and buys-to-open (BTO) another option. The BTO 5-10 points further OTM premium received for the STO is always greater than the premium paid for the BTO thus, creating a net credit to the account. Same Expirations Example: STO a call using the 120 strike for a credit of $5.20 BTO a call using the 130 strike for a debit of $3.80 Net credit for the spread is $1.40 The proper construction of a credit spread is to STO an out-of--the-money (OTM) strike and BTO the strike that is 5 – 10 points further out-of-the-money (OTM) but using the same expiration. When opening a call credit spread, further OTM means a higher strike. When opening a put credit spread, further OTM means a lower strike. Both legs are opened on the same underlying equity and use the same expiration month. Page | 4 Copyright 2013, Options Money Maker, LLC Trader’s Guide to Spreads Credit Spreads…Continued… Call credit spreads are opened when there is a declining bias and will be profitable if the stock moves down. This is because a call credit spread is opened for a credit and since the value of a call option decreases as the stock goes down, at some point the spread will be bought to close for less than it was sold to open. Here is an example: Stock trading at 500 and has a declining bias. STO 510 call This spread creates a credit of $4.80 BTO 520 call Stock declines to 490 causing the values of the calls to also decline. The position can now be closed for a profit. BTC 510 call The cost to buy back the spread is only $3.80. Since the stock declined in STC 520 call value the call options are cheaper. The spread was STO for a credit of $4.80 and BTC for a debit of $3.80 resulting in a $1.00 profit. Put credit spreads are opened when there is a rising bias and will be profitable if the stock moves higher. This is because a put credit spread is opened for a credit and since the value of a put option decreases as the stock goes up, at some point the spread will be bought to close for less than it was sold to open. Here is an example: Stock trading at 520 and has a rising bias. STO 510 put This spread creates a credit of $4.80 BTO 500 put Stock rises to 530 causing the values of the puts to decline. The position can now be closed for a profit. BTC 510 put The cost to buy back the spread is only $3.80 because since the stock STC 500 put went up in value the put options are cheaper. The spread was STO for a credit of $4.80 and BTC for a debit of $3.80 resulting in a $1.00 profit. Time decay is a positive factor in trading credit spreads. Since the position is opened for a credit, money comes into the traders account immediately. As time value decays, combined with a favorable movement of the stock, the value of the position will decrease allowing the trader to buy-to-close (BTC) the position for less than it was originally sold-to-open (STO). Page | 5 Copyright 2013, Options Money Maker, LLC Trader’s Guide to Spreads Risk and Reward on Credit Spreads Reward The maximum profit that can be earned from a credit spread is equal to the net credit received when the spread was opened. For a credit spread to realize the maximum profit, both legs of the spread would need to expire worthless which means the position would need to be held until expiration. Options Money Maker traders do not hold positions until expiration. Short term movements in the stock plus time value decay provide opportunities to close out positions for a profit of, generally, about 10%. If a position is profitable and the trader decides to hold the position hoping for a bigger profit or in an attempt to carry the position to expiration, there is a good chance that the profit will disappear and the position could turn into a losing position. “A good way to lose money is to wait for a bigger profit” Years of Experience Risk The maximum risk or potential loss from a credit spread is the difference between the strikes minus the net credit. Example: STO 120 call for a credit of $5.20 The difference between the strikes is 10 points.
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