By: Steve Smith
In the past few posts, I’ve discussed how the Options360 service has been employing credit spreads. Whether it’s been the iron condors in index products, such as SPDR 500 (SPY) and Nasdaq 100 (QQQ) pre-election, to take advantage of the expected decline in implied volatility, or fading the extreme moves we’ve seen on viable vaccine news.
The one commonality is that I’m taking advantage of two important tailwinds; an expectation for a continued decline in overall volatility and the unrelenting march of time decay (theta). Backing up a bit, let’s review what a credit spread is, and some of its pros and cons. They come in the form of calls and puts, allowing both long and short credit positions. It’s created by simultaneously buying and selling either puts or calls with the same underlying security and expiration, but with different strike prices.
Two main credit spread benefits are 1) you don’t necessarily need to be right on a directional basis to make money and 2) they benefit from time decay. A third, if the less quantifiable aspect is that credit spreads offer tremendous adjustment flexibility — be it profit taking or defending a position. The other day, I disclosed my bearish call spread in Brinker (EAT). That turned out simple and we closed it on Wednesday at $0.15 for a 45% return on risk and 65% maximum profit potential in just two days as the combination of a decline in price and drop in implied volatility worked to Options360 members’ benefit.
Note: I’ll always close a position once it has neared 75% of the potential maximum profit. For credit spreads, I’ll close the trade once the value slips below $0.10, as the risk/reward becomes asymmetrical. Trying to pick up the last dime while steamrollers rumble by can be hazardous to your financial health. The QQQ and SPY iron condors become a bit more problematic as both indices staged surges, which threatened our iron condors call strike. In both cases, I simply rolled up the put side to collect additional premium, reducing risk and allowing time decay to go back to the forefront of the force and delivering profits. My Paypal (PYPL) bull put spread has been the most challenging; starting as a simple put credit spread in the 177.5/182.5 strikes. When shares dropped below $180 yesterday, I took action and sold the 192.5/197.5 call spread, creating an iron condor and collecting a $1.90 total premium. Now, PYPL’s back above $190. The question is: Do I need to make another adjustment? Or, just white knuckle it for the next few days and let time decay do its thing?
Stay tuned, or better yet…