Options Trading Tips: Vertical Credit Spreads [Options Strategy 2020 Update]

Options Trading Tips: Vertical Credit Spreads [Options Strategy 2020 Update]


Options trading strategy. Why it’s better
to trade vertical credit spreads than naked options. David Jaffee with BestStockStrategy.com, you can visit BestStockStrategy.com enter in your email
address and receive over $400 of valuable free training in this video we
are going to discuss why it’s better to trade vertical credit spreads as opposed
to naked options trading spreads is actually something that is counter to
the way that I used to trade up until about 6 months ago I almost always
traded naked options however recently I have started switching over to trading
spreads and the primary reason is that the increased capital efficiency and the
tail risk protection from trading and selling spreads outweighs the increased
amount of premium and the increased ease that you have when rolling and managing
positions so again stated another way I believe that the capital efficiency and
the tail risk protection of turning that into a defined risk trade outweighs this
small decrease in premium that you receive and also the increased
difficulty that you will have when rolling and managing a defined risk
trade relative to a naked option so this is probably the biggest way that I’ve
actually changed my trading in 2019 I now primarily trade spreads as opposed
to naked options and actually I trade spreads with virtually every single
security so before I used to only trade spreads with a very expensive security
like Amazon or Google just for capital efficiency purposes but now I believe
that trading spreads provides you with a substantial advantage it is more capital
efficient and additionally it provides you with tail risk protection as an
example for the capital efficiency your broker now again okay let’s use 100
shares of stock 100 shares of naked options and 100 shares of a 4:1 contract
of a $5 wide spread if a stock is trading at a hundred
you buy a hundred shares your broker is going to reduce your buying power by
five thousand dollars so you buy a hundred shares of a hundred dollar stock
that is a notional value of ten thousand dollars therefore based upon regulation
T your broker is going to reduce your available buying power by five thousand
dollars if you sell a put with a strike price of a hundred dollars that allows
you to control an option or a hundred shares of that of the underlying stock
at a price of a hundred dollars so it is for all intents and purposes similar
were comparable to buying and going long a hundred shares of stock your broker is
going to reduce your buying power by twelve to twenty percent it depends upon
the calculation but let’s just estimate it and say fifteen percent so remember
you’re buying a hundred shares of stock your buying power is going to be reduced
by five thousand dollars by selling one naked put option with a hundred dollars
strike your buying power is going to be reduced by about fifteen hundred dollars
if you sold a five dollar wide vertical credit spread you would sell the hundred
strike you would buy the ninety five strike and let’s say you would collect
around $1 of premium that means that the broker would reduce your buying power by
only $400 because brokers reduce buying power with spreads on the maximum loss
which would be five hundred dollars per contract less the credit received so
that would be four hundred dollars so again if you buy all hundred shares of
stock your buying power is going to be reduced by five thousand dollars if you
sell a naked put your buying power in this example is going to be reduced by
fifteen hundred dollars if you sold a vertical credit spread your buying power
will be reduced by four hundred dollars that means that this spreads are about
four times more capital efficient than selling a naked option and in this case
they are about 12 times more capital efficient than stock and you have the
incremental benefit of half of turning it into a defined risk trade and
limiting your downside so if the stock fell to a
dollars than the maximum amount of money that you could lose on a net basis
factoring in the premium that you received for the vertical credit spread
would still only be four dollars or four hundred dollars per contract that you
sold this is one of the major changes that I’ve made to my trading over the
past six months and you can learn more about it by going to best stock strategy
comm slash memberships you can go and visit best stock strategy com enter in
your email address and receive over four hundred dollars of valuable free
training my students consistently make money in this by trading options you
will learn how to be a consistently profitable options trader leave a
comment below and let me know your thoughts on whether you believe it’s
better to trade spreads or whether you still believe it’s better to trade naked
options the one caveat is that it’s very important for you to not substantially
increase your size so even though in this example that I provided you trading
a spread is four times as capital efficient as trading a naked option that
should not permit you to then sell four times as many spreads as you would have
traded naked options so for example if you were going to trade five naked
options if you were going to sell five naked options you should not go out and
sell twenty vertical credit spreads that is the biggest mistake that I see people
who end up losing money by trading options they just simply trade too big
David Jaffee from BestStockStrategy.com please leave a comment below I respond
to everyone’s comments and I look forward to reading your thoughts on
whether you believe it’s better to trade spreads or whether you still believe is
better to trade naked options