One of the best ways to generate consistent income is…
… using this little known trading strategy…
Few traders realize that trading it— is essential to minimizing the risk in their trades.
And this totally blows my mind!
One benefit of trading options is not only can you make a steady income… but you can do this in any market condition!
It doesn’t matter if the market is trading up, down, or sideways. There is always a strategy to make money!
But instead of going through the whole options alphabet of strategies.
Today, we’re going to focus on credit spreads. A strategy that works under all market conditions and one that stacks the odds in your favor.
Options are a popular way to place a trade in a stock without having a capital restriction that many traders who are trading stocks have to deal with.
One major advantage of trading options over stocks is making money like a casino does.
When buying options, you have the right but not the obligation to buy or sell a stock at a specified price using calls and puts.
However, options have significantly more complex factors that impact their price compared with stocks.
And this could be a major deterrent for traders.
But it doesn’t have to be.
Options are like a double-edged sword, with its good and bad characteristics.
For example, you could have a huge return on your investment but also lose far more taking those bets.
So if you are trading options it is a must to learn how to trade credit spreads to generate income.
Why is that?
Well, no matter the direction the markets move, options have a strategy for it. One of my favorite trading styles is to be an option seller and get those house odds in my favor.
And by trading credit spreads it also allows you to trade strategies that significantly minimize your risk compared to buying options and even trading stocks.
Trading Credit Spreads For A Living
What is a credit spread?
A credit spread is a directional strategy where you buy an option at a nearby strike and sell an option at a further strike in the same month for the same stock.
Let’s see what a Credit Spread looks like compared to a Naked Option.
Here is an image of a credit call spread on AAPL.
And here is an image of a naked call on AAPL for comparison.
Even though very unlikely in AAPL, it’s clear to see that the upside risk certainly exceeds the possible gains you can see.
This is a poor risk-to-reward profile and a trade that is highly recommended to avoid. Not to mention many brokers will not allow Naked Calls on their platform due to the risk exposure from them.
There are many advantages to trading a credit spread compared to naked options.
Some key advantages are:
- Credit spreads are cheaper than naked options due to margin requirements.
- Credit spreads minimize losses if the stock goes against you.
Similar to trading calls and puts a credit spread can be bullish or bearish to capture the direction of the underlying stock.
Naked puts and calls have unlimited losses whereas credit spreads are protected.
Think of credit spreads like hedging your bets.
Pro Tip: Credit spreads can be bearish or bullish. Make sure to choose the direction when trading credit spreads.
Credit Spreads are generally low-risk
There are a few things that I need to know from my trades, but these two are a must.
- My profit potential
- How much capital am I risking
Remember, credit spreads and sometimes even naked options (if traded with stock) are useful risk management tools.
For example; if I am long XYZ stock and feel that it has temporarily stalled out, I may be inclined to sell a call against my long stock. This position is a Covered Call and is a great way to generate additional income for an equity trader.
Putting It All Together
Trading credit spreads for a living is a great way to generate income and eliminate many risks associated with this trading style.
Let’s take a look at some pros and cons to trading credit spreads:
- House odds in favor of seller (60% or more)
- Limited downside risk
- Can win in up, down, and sideways markets
- Lower capital requirements vs Naked Calls
- Limited upside gains
- Slightly higher commissions
It’s easy to see how the pros of trading this strategy significantly out-weight the cons!
Trading credit spreads for a living means that your goal is to receive and keep the credit on that trade.
This is your income and cannot make additional money past that.
And it’s ok!
Ideally to a credit spread trader, they want their entire profits to be seen which means that all of their trades must expire worthlessly.
However, that does not happen all the time.
Remember, if you have a good profit in your trade (say 50% or more in profits) it might be a good idea to lock that in.
After all, a trader never goes broke by taking profits.