Credit Spread Option Strategy
What are the characteristics of this option strategy?
A credit spread option strategy is a popular option trading strategy that seeks to generate income while limiting risk. Credit spread options involve selling at the money option and using the credit received to buy out of the money option. The strategy’s risk is limited to the difference in strike prices less any premium received.
Is this a bullish, bearish or neutral strategy?
Credit spread option strategies can be deployed in either a bullish, bearish or neutral direction, depending on the option trades used. For example, a bearish credit spread would involve buying a higher strike price call option and selling a lower strike price call option.
Is this a beginner or an advanced option strategy?
Credit spread option strategies can be considered a moderate skill level option strategy. A new trader needs to be familiar with the key options trading concepts before deploying a credit spread option strategy.
In what situation will I use this strategy?
Credit spread strategies are most commonly used when an investor expects that the underlying will not move past a certain price. By selling a lower strike price option and buying a higher strike price option, the maximum potential loss is defined as the difference in strike prices minus the premium received.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
A credit spread option strategy typically falls in the middle of the range of risk-reward and probability of profit. The maximum risk of using a credit spread option strategy is the difference in strike prices minus the premium received. Depending on the underlying’s final price will dictate whether or not the strategy was profitable.
How is this strategy affected by the greeks?
The greeks will impact the position of a credit spread option strategy as they will with any other options trading strategy. The delta, gamma, theta and vega of a credit spread option strategy will depend on the underlying, strike prices and expiration dates of the options used in the strategy.
In what volatility regime (i.e., VIX level) would this strategy be optimal?
A credit spread option strategy is typically best suited for moderate levels of market volatility. If market volatility is too low, it can be difficult to sell options for a decent premium. If volatility is too high, it can increase losses quickly due to higher gamma and delta movements.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
If the trade goes against a credit spread option strategy, it can be adjusted with options trades to try and bring the trade into profitability. A trader can roll down the lower strike price, buy back the higher strike price and then sell a new higher strike price option. This strategy can be complex to adjust, so the decision should be carefully weighed against the probability of success.
Where does this strategy typically fall in the range of commissions and fees?
A credit spread option strategy typically falls at the higher end of the range of commissions and fees. The two-leg nature of the strategy will require two round trips and two executions to both enter and exit the trade.
Is this a good option income strategy?
A credit spread option strategy can be a good option income strategy. Option income typically comes from selling options, so by selling a lower strike price option and buying a higher strike price option, a trader can benefit from the premium received and collect option income in the process.
How do I know when to exit this strategy?
The decision to exit a credit spread option strategy will depend on several factors, including the underlying’s current price, the option positions’ delta, and the strategy’s risk-reward objectives. If a trader notices that the delta is getting too high and the underlying is moving in the wrong direction, it may be wise to exit the position before a large loss is incurred.
How will market makers respond to this trade being opened?
When a credit spread option strategy is opened, market makers may widen the spread on the options involved to offset the costs associated with taking a risk on the spread. Market makers typically benefit from spread trades when they can buy a widespread while selling a more narrow one, so they may respond by doing the same.
What is an example (with calculations) of this strategy?
For example, if an investor is looking to construct a bearish credit spread on MSFT with an underlying at $255 and an expiration date of 5 days, they may sell the $255 call option and use the proceeds to buy the $265 call option. This will result in a net credit of $352. If the underlying remains below $255, it would result in a maximum profit of $352. If the underlying was to move above $265, it would result in a maximum loss of $646.
MarketXLS and How it Can Help
MarketXLS is a powerful tool designed to help traders analyze and execute credit spreads from directly within a single spreadsheet. With its intuitive options calculator, traders can quickly and easily construct both long and short credit spreads, like Short Guts and Vertical Spreads. MarketXLS helps to calculate the risk and reward for each spread, and make the trade setup quick and easy. MarketXLS’s one-click option lookup quickly presents detailed option chains to make trade adjustments and execution a breeze.
Here are some templates that you can use to create your own models
Short Gut
Call Condor Spread
Iron Albatross Spread
Put Ratio Back-Spread
Call Ratio Back-Spread
Short Butterfly Spread
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
The Benefits of Using Call Credit Spreads for Trading
Vertical Options Spread (Using Marketxls)
Call Ratio Spread-Neutral Option Strategy
Bull Put Options Strategy
Diagonal Spread With Calls Option Strategy (Excel Template)