Option Spread Trading – Advantage Trader
You may wish to consider the advantages of option spread trading over simply buying calls or puts and hoping for the market to go in the anticipated direction, if consistent positive cashflow from option trading is your aim. Option spreads can be used in a number of ways, from the simple debit or credit spread, to more advanced and complex strategies such as the calendar spread, the butterfly, the iron condor and the like.
So what is it that defines option spread trading? It is simply about taking opposite positions in terms of buying to open and selling to open (ie. writing) a number of option contracts for the same underlying financial instrument, but using different strike prices or expiry dates, thus creating a spread of positions as part of a single strategy.
Creating an options spread trade can give a number of advantages. Firstly, although it will cost you more in brokerage, the overall position will ususally be cheaper than just straight out buying. This can make all the difference if your trading capital is not very much. Your trades will cost less, so you have more control over money management.
Secondly, options spread trading will usually eliminate or reduce the element of option price volatility, or at least allow you to use it to your advantage. Volatility is when an option strike price becomes inflated or deflated in comparison to the historical volatility of the underlying, due to high or low demand at the time.
Thirdly, options spread trading will allow more flexibility when choosing the expiry date. Because you are selling to open as well as buying, you can often stretch out the expiry date of both positions without affecting your overall cost for the trade. This will allow you more time to be right and make a profit.
You could even now ‘average down’ by taking out another call debit spread at lower strike prices. The combination of this new spread, plus the long call still held from the old position, could make you well over 100 percent profit on your investment, even if the stock only returns to it’s original level at the time of your original trade.
The above scenario assumes the underlying is not now taking a long term nosedive due to some financial crisis or extremely bad news. If this happens, you would start concentrating on bear put spreads. The profit on the put spread would offset the loss on the call spread.
With option spread trading, you can sometimes take advantage of the situation even when the price goes against you. Let’s say you have taken a call debit spread, seeing that the price of the underlying has fallen recently and believing it is due for a rise. But to your disappointment, it continues to fall. This now means that your ‘sold’ position, being further ‘out of the money’ than your bought positions, will be very cheap. So you can now buy it back for a fraction of what you received for it. If you’ve allowed yourself plenty of time, you now hold only your bought position and simply wait for the underlying price to rise again.
Main Types of Option Spread Trading
Debit Spreads – are when you simultaneously buy a position with a strike price close to the present market price of the underlying stock or whatever – and sell to open for the same expiry date but further away from the current market price. This will take funds from your account and is therefore called a debit spread.
Credit Spreads – these occur when you do the opposite to the above. You sell closer to the current market price of the underlying and buy further ‘out of the money’. Since the option prices closer to the money will be more valuable than those further away, you will receive a credit to your account.
Other Spreads – There are more advanced strategies, such as ratio backspreads, range trading spreads like calendar spreads, butterflies and condors – and delta neutral spreads such as straddles and strangles. They are more difficult to explain and each one of them could be the basis for an article in itself.
Option spread trading provides the trader with some powerful advantages over simply ‘going long’ on an option contract. These advantages give greater flexibility when things go wrong, decrease your cost per trade and allow you to extend the expiry date of your positions (assuming there is sufficient open interest) at little or no greater expense. There are some other things you need to pay attention to, but if understand what you’re doing, there is a tremendous amount of money that can be made.
Option Spread Trading – Contents
Victory Spreads are a powerful way to make money with options. There is virtually no risk but with massive profit potential.
Vertical spreads involve a combination of options positions where an equal number of options are simulatneously bought and sold but with the same expiration date.
How to do Credit Spreads
This matter of how to do credit spreads is really interesting. There are huge benefits with this nice option trading strategy and you can choose either a low risk trade or a high probability trade.
Rolling Out – Advantage Credit Spreads
So what is the advantage credit spreads give us? This example will demonstrate how we can turn a losing trade into a profitable one.
Rolling Credit Spreads
When rolling credit spreads there is one simple rule which you need to know to ensure you keep your profits. Monitor the net value of your original position and don’t leave it until it’s too late!
With credit spreads you can use option ‘time decay’ to your advantage and give yourself an 80 percent trading edge! Here’s how …
Trading Credit Spreads
Have you considered the advantages of trading credit spreads with the short position in-the-money and the long (bought) leg of the spread at-the-money?
The Bull Put Credit Spread
The Bull Put Credit Spread is a low risk, flexible option trading strategy that is normally employed when you are bullish about an underlying security.
The Broken Wing Butterfly Spread
The Broken Wing Butterfly is a variation of the traditional option butterfly spread. The main difference is the choice of strike prices.
The Iron Condor
One trap that iron condor traders fall into, is that they wait until it’s too close to expiration date before exiting the position. By this time, your ability to adjust the trade has been compromised.
Iron Condor Setup
An effective Iron Condor setup involves getting a few critical things right and matching them with your preferred trading style. Get this right and you can’t go wrong.
Iron Condor Strategy
An effective Iron Condor strategy involves getting a few critical things right and matching them with your preferred trading style. Get this right and you can’t go wrong.
The Bear Call Calendar Spread
The bear call calendar spread is a combination of the option credit spread and calendar spread strategies. It is simply a credit spread but with an expiration date variation.
Debit Spread Example
The following debit spread example shows how that, even when the price of the underlying financial instrument goes against you, you can still make a nice profit on your investment.
Calendar Spreads are a popular low risk, high profit potential, options strategy for traders who believe that an underlying security, is going to be trading within a range in the near term.
Ratio backspreads are considered to be one of the safest longer term option trading strategies available today – so much so, that they have sometimes been called “vacation spreads”.
Ratio Call Spread
The ratio call spread is used when the trader believes that the price action in the underlying market will remain within a range that is above it’s current position.
Backspread Option Strategy
The backspread option strategy covers a number of setups, all designed to profit from volatile market conditions. Backspreads are the opposite of frontspreads.
Put Ratio Backspread
The put ratio backspread is an option setup that profits from anticipated price drops in the underlying while still realizing some profit if you got it wrong.
Bear Put Spreads
Bear put spreads are created by buying put options with a strike price close to the current security price and selling the same number of put options at a strike price lower than the bought options.
The Double Calendar Spread
Before you consider placing a double calendar spread, there are a couple of things you need to see in both the underlying and the options themselves.
The Diagonal Spread
The diagonal spread is one variation of option spread trading that has been used most effectively to adjust existing spread positions.