What are the characteristics of this option strategy?
Credit spread option strategies sell one option and buy a further out of the money option of the same type and expiration, keeping the net premium. The credit received is the maximum profit. The long option is what caps the risk, so it has to stay in place for the whole life of the trade. If the long leg is closed and the short leg is left on, the position becomes a naked short option with uncapped loss. With both legs on, the risk is limited to the difference in strike prices less the 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. In a bear call spread, selling a lower strike call and buying a higher strike call defines the maximum potential loss as the difference in strike prices minus the premium received. A bull put spread is the mirror image: sell the higher strike put, buy the lower strike put, and the same width rule applies.
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 the short leg up and out: buy back the lower strike call that was sold, sell a further out of the money call in a later expiration, and roll the long higher strike call out with it so the spread stays fully covered at all times. 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, and pairing the short option with a long one further out of the money lets a trader collect the premium with the loss capped at the strike width. The premium is small relative to that capped loss, so a single loser can undo several winning months.
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 at or below $255 at expiration, both calls expire worthless and the trader keeps the full $352, which is the maximum profit. The strikes are $10 apart, so the spread is worth at most $1,000 against the trader. Subtracting the $352 credit, the maximum loss is $648, and it is reached once the underlying is at or above $265 at expiration. Breakeven sits at $258.52, the short strike of $255 plus the $3.52 per share credit.
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)