Why I’m Using Credit Spreads to Profit in This Market

Why I’m Using Credit Spreads to Profit in This Market

Posted On September 29, 2020 3:30 pm

Over the past few weeks, I’ve espoused how I don’t think the recent 10% garden variety ‘correction’ represents the worst of the selling and expect larger declines in the coming weeks. 

Well, I got thrown for a loop last Friday and Monday as both the “SPDR S&P 500 (SPY)” and the “Nasdaq 100 (QQQ)” rallied some 3% between the two days — leaving me to scratch my head, pondering whether this was just another dip to be bought. The charts certainly pointed to double-bottom formations and that we’d soon be back to races with new highs in sight.  But, as I’ve been discussing, I’ve shifted my approach to rely on credit spreads to help turn the odds back in my favor. 

The most recent Option360 Service trade is a good example; it’s a bear vertical QQQ call spread. I sold the October 277 (10/09) call and purchased the October(10/09)  280 call, for a $1.10 net credit. I collected a total of $1.10 premium which we would keep should the QQQ’s be below $277 on the 10.09 expiration. 

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This means the maximum gain is the $1.10 I collected (57% Return on Risk).  The maximum risk is $1.90, for a potential 57% Return on Risk over the 12-day holding period. Add delta to the equation and the position has a 78% probability of turning a profit. I like those odds. The original trade recommendation was posted to members on 9/22.

qqq invesco trust chart

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As you can see, the timing was right with the QQQs dropping over 2% the following day.  I followed up with an alert to sell a bull put spread to create an iron condor (essentially locking in gains). But, the market rallied too far too fast. Now, we stand where we began. 

However, two items have moved in our favor:

  1. From a technical standpoint, the QQQ’s have been rejected at the line of resistance I highlighted — the 277ish level. 
  2. A week of time decay (theta) has now passed. This provides our credit spread with a solid tailwind as it’s value will continue to diminish. This is good. Remember, we sold this spread for credit, and we’re looking to close it at a lower price. Sell High, Buy Low.

One of the many things I love about the Option360 Service is it’s “unconstrained” approach.”  Meaning, choosing the option strategy that best aligns with your thesis and trading environment. Currently, we’re in a wide-ranging, high volatility phase that’s made credit spreads, both bullish and bearish. This is my go-to option strategy of late. 

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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