| I Lost $80,463 Trading Option Credit Spreads |
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| Written by Morris Puma |
| Tuesday, 27 October 2009 21:16 |
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Hello option traders and welcome to this discussion about credit spreads. In a few words today we'll be discussing why it's so important to have adjustment plans before you enter into a short-term credit spread options trade. Although the credit spread is very popular amongst option trading community the high risk in the trade is not always talked about. Credit spreads can be very risky trades if they are not being hedged by other option strategies, and being that most option traders do not know how to hedge this position, many of traders are losing their trading capital on a daily basis.
Hello option traders and welcome to this discussion about credit spreads. In a few words today we'll be discussing why it's so important to have adjustment plans before you enter into a short-term credit spread options trade. Although the credit spread is very popular amongst option trading community the high risk in the trade is not always talked about. Credit spreads can be very risky trades if they are not being hedged by other option strategies, and being that most option traders do not know how to hedge this position, many of traders are losing their trading capital on a daily basis. The credit spread is one of the most popular option spreads traded today. The reason is because the credit spread is simple, it makes money over time and it is a trade with a high probability. But this probability rating can be very misleading. The dangers of the credit spread are rarely addressed in books and online credit spread courses. The sad truth is that most people teach the credit spread because it's a good business, but not because it's a good option strategy. It's actually a very risky trade and very directional. Trading Option Credit Spreads 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. Option courses pushing credit spreads do not tell you about the risk. They do not tell you how far you can be behind on this trade just a few days after you enter it. They don't value how you can lose 90% of your trading capital in one month. They don't tell you how this 90% probability trade can lose the very first month of its existence. Just because the trade has a 90% probability, doesn't mean it makes money nine times before it loses once. This just means that it makes money 90% of the time out of a lot of trades. You might have to do 1000 trades before his trade averages its 90% probability. The problem with the credit spread, in particular, the short-term credit spread, is that it's a very directional trade. Even though it has Theta on its side, it has Delta and Gamma working against it. For the small amount of Theta that you get from a short-term credit spread, you are picking up even more danger by trading this option spread with very high Gamma. What this means is that as the price of the underlying changes, the profit and loss on the trade also changes very quickly. This type of trade is a lot more volatile and risky than most beginning option traders know. Finally I would like to say that credit spreads can be used effectively in an options portfolio. Normally however, the credit spread should be combined with another options strategy. This will limit a risk and increase your return potential each month. There is a place for credit spreads in my portfolio, but if you are thinking of doing them alone as a standalone strategy, then I encourage you to think again. DISCLAIMER: This article is provided as information only and is not to be taken as financial advice. Learn Maximum Safety, Maximum Return Option Credit Spreads in our Live Options Trading Rooms at San Jose Options. |