Playing credit spreads in a bearish market
November 19, 2022
Intro
I am by no means a financial analyst but I do have a decent understanding of the US markets and for the past several years I have been able to capitalize and grow my investment accounts substantially through stock derivatives. I do of course invest in companies I have a belief will grow and for those investments I look for high yield dividends that will pay me every quarter for additional income. In this post i’d like to go over one of my favorite option strategies that has worked well for me especially during this bear market that we are in at the moment and I am enjoying the speculative aspect of trading and growing my net worth.
Vertical Spread Strategies
Call Credit
This year we have seen a lot of fear in the markets and that has shown with an increased sell off. One of the more liquid underlying assets many traders use is SPY. From September to October with high inflation rates and the fed trying to combat this we saw the S&P fall from a high of 4100 to lows around 3500 with fears of not seeing a bottom until around the 3200 range. During this time frame I employed one of my favorite strategies - the call credit spread.
What I love about this strategy is I am paid a premium that I get to keep and if my theory is correct I get to have the max gain on the trade at the time of expiration. What vertical spread strategies allow for is reduced risk with limited profit potential. When I first started to really trade the markets to be honest I was losing and one thing that a friend told me that has stuck with me is that buyers of options are for the most part the losers and sellers are winners. When selling these spreads you should always look for receiving a credit upon entering the trade for the contracts that you have sold. The long option is what protects you if the play goes against you.
During this time of fear we can capitalize on a down market and earn big every day we employ this strategy.
Bull Put
On the flip side when I am feeling bullish on a specific underlying I will employ a put spread in which we have one short put with a higher strike price and one long put with a lower strike price. With this trade we will also receive a credit upon entering and we benefit from the stock going up which increases the value of our contracts. The maximum profit realized is also the amount of credit that we received upon entering once the contracts expire worthless.
Pin Risk
These strategies are not without some risks and you can still lose an incredible amount of money if you are not educated on what could happen. A scenario I am always mindful of is pin risk in which there exists uncertainty around how many contracts may get assigned at expiration. I generally avoid this ever happening to me and blowing up my account by getting out of trades a few hours before the contracts expire. When I let the contracts expire and do not touch them is only if they are far out of the money (OTM) and I know I have won the trade. If there is a chance we can potentially go one cent in the money (ITM) I am generally out of the trade around 2-3pm before expiration and will cut my losses there.
Personal blog by Alex Virdee, 