That is the question a member asked me today. His question has to do with why a credit spread is showing a loss when the stock is still above the short strike.  Valid question, and one that I get asked a lot by newbies. Here is the question, the answer, a follow up question, and a basketball example. The question is in blue, and my response is in red.

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Now I need to be educated a bit.  I have a question about the very last trade that you placed on April 28th, where you sold 4 May 1310 puts and bought 4 May 1305 puts.  The SPX was at 1355.77 when you placed the trade so I am assuming (perhaps wrongly) that the goal is for it to stay above 1310 and if so we keep the full credit. exactly  
 
I paper traded this along with you and I am not sure if what my position page of my account is showing is really the story on this trade and I would appreciate your input.  In the gain/loss column next to this trade from day one has shown a negative.  I am trying to figure out if that is correct that we really are in a loss position currently or can we not go by that if we are doing a credit spread where the goal I think is for both the puts we sold and bought to expire worthless so we keep the credit.  you would want it to show a profit. I think it did show a profit in the beginning, but as of right now I am seeing a $40 loss. but that is ok because th eoption prices fluctuate so sometimes these numbers are not exactly “accurate”
 
If the SPX is still above 1310 I would think we would be in a positive position since that is what needs to happen at expiration in order for us to win or profit on this trade.  I know that time value has to be factored in but still I would think the trade would be postive at this point unless I am missing something.   I am even wondering if perhaps a negative loss position at this point is really a good thing because we want them to expire worthless, or am I overthinking this and if it shows a negative currently then the trade really is working against us currently.  Yes, if it shows a loss, the trade is not going in our favor it is going against us.
 
 I did not know if the software with options express is smart enough to take into account the strategy that we are using and therefore the gain/loss they are showing is always correct or do we have to do something different with that information to know where we really stand in the trade at any given time?  If the latter is correct then it would be great to see an article or something that explains what modifications or interpretations we have to make to what is reported on our position page for the different types of trades that you make in order to know where we really are at any given point in time.  Please help, I may just be lost deep in the woods but I am confused and need some assistance. the strategy has nothing to do with it. As days go by the options will lose value and the p/l will change but the p/l is showing you what is happening today, you are talking about expiration so if you exited the trade today, you would lose money since it is showing a negative. does that make sense?
 
Don’t you just love novices?  Hey man, I am trying and studying like crazy but sometimes it all runs together and gets overwhelming.
It will take some time, but you are getting the hang of it.
Thanks for any help and clarification you can provide.

Here is his follow up question (in blue) and my basketball analogy (in red)

Very helpful Allen, thank you.  So one final question then.  If the goal is for it to stay above 1310 at expiration so we keep the full credit, and it is above that currently, then why is it showing a loss.  I understand that you are saying that if we exited now it would be a loss, but why is that the case if it is already above where it needs to be at expiration.  I am sure the answer to this is the key for me to understand how it all fits together.  It would seem to me that we are above where we need to be at expiration so we are in a “gain” position and all we need to do is remain there?

Maybe an example would work better.
 
Lakers/Mavericks Game 3.
Mavericks are up 2-0 in the series and they are playing in dallas. (hope you watch basketball and know what i am talking about)
 
You think dallas will win and you bet $100 on the game.
The odds are 1:1.5 so if you bet $100 and you win you will get $150 back.
 
Fast forward: It is half time and the lakers are winning by 10 points – if you were the place the bet now you would get 1:1 odds – bet $100 and win $100.
 
So where do you stand if you want to get out of your bet?
 
Dallas could still win but you have to wait till the end of the game. But if you want a buddy to take over your bet, then you need to pay him $50 because he is taking on more risk than you did.
 
Same with our spread, if you want to exit now, you have to pay up because the trade/game has not gone in your favor yet.
 
If on the other hand, SPX had gone up 100 points, our trade would be showing a profit and we could exit with most of it in tact. We would not get the whole credit because of the time value of the options (there is still a small chance SPX might drop all the way).

Showing A Loss Before Expiration is a post from Option Selling.
To learn how you too can earn 8-12% Monthly Returns Safely and Conservatively check out OptionGenius.com

Hello OptionGenius.

I have been trading credit spreads for about 3 months now with some success.  I read the nine part  course and realize that my past training didn’t discuss much about selection of trades and adjustment of trades.  When I was looking around the website, I saw a brief reference on how you scan for and pick your trade opportunities, how you use the mathematical models with standard deviation to help your selection and how to determine exit points., but there weren’t too many details on these topics.   Do you share the information about scans, about the mathematical models and how to use them as the subscriptions move along?

Eric,

For credit spreads most traders use technical analysis to find support and resistance and use those levels to pick strikes. I have found that, that strategy works except when it doesn’t. support and resistance are guidelines not walls that the stock will not go through and so you will do fine for several months until one month, something happens that was not expected and you lose big on your credit spreads and that wipes out all the profit from the prior months. Credit spreads are pretty dangerous. They are hard to adjust because you are hoping the support stays in place.
 
For example, I have a credit spread on right now in my personal account. It is a POT Oct 85/80 Put credit spread. So I want Pot to stay above 85 at expiration which is 10 days away. yesterday, POT got to 85 and change. Today it is back to 88.80. So the resistance held,(lucky for me). But if I had tried to adjust the trade I would have gotten killed. Credit spreads, from my experience, are trades you put on, wait and take them off if they are going to be a large loss or a total win. There is not much in between.
 
For the other income strategies, you look for stocks.indexes/etfs that are channeling – moving in a sideways direction. any of the strategies can be used on such a stock. But the best thing to do is to focus on a few – maybe 10 that you get very familiar with and trade those month after month. Blue Chip Dow 30 stocks are usually good candidates – MCD, WMT, KO, PEP, XOM, PG, etc. Their volatility is lower and the prices are high enough to make the options have enough premium to work with.
 
But stay away from earnings. Don’t do income trades during earnings.

How Do You Scan For Trades? is a post from Option Selling.
To learn how you too can earn 8-12% Monthly Returns Safely and Conservatively check out OptionGenius.com

With a debit spread, the max you can lose is the amount you paid for the trade. The max you can gain is harder to determine. I do it using the Analyze tab on my broker’s platform. On a butterfly you can make up to 200% of the debit and sometimes more. On a Calendar you can make 100% of the debit. But you normally will not. At expiration, the profit zone becomes very narrow and the Greeks (delta, gamma, theta, and vega) become very volatile and option prices make huge swings up and down.

On either of these trades, 20% profit is a good number to shoot for. So if the trade costs you $1,000, aim to make $200-$250. Once you hit your target profit, you can take some of the trade off to protect your profit and stay in the trade to see if you can make more.

But with a debit trade, you have to sell the trade to get your money. If you let the options expire, you lose everything you paid. So be sure to keep that in mind.

It’s the opposite with a credit trade. Here you get money to make the trade, and the money you get (the credit) is the max you can make.

So let’s look at a simple credit spread.

I sell 2 of the AAPL Oct 155 Puts and buy 2 of the AAPL Oct 150 Puts for a credit of .62

In this trade I want AAPL to stay above 155, if it does, I keep the entire credit.

 Since the trade consists of 2 spreads (2 Sold and 2 Bought) I multiply the credit times 2 to get my total credit. .62 x 2 = 1.24. In dollars this translates to $124 credit, which is the most I can make on this trade.

 Now let’s calculate my max loss.

 The strikes I traded were the 155 and the 150. The difference between them is 5 points, or in dollar terms, $500. That is the most I can lose on each spread. Since I did two spreads the most I can lose on this trade is $1,000.

 But wait. I also collected the credit, and that is mine to keep no matter what happens. So we take the credit and subtract it from the difference between the strikes.

 1000-124 = 876. This is the max I can lose on this trade. This is also the margin/account balance I am required to have in my trading account to be able to make this trade.  I am risking $876 to make $124.

 If I divide 124 by 876, I get a potential return on my money of 14%.

 This was a simple credit spread. In an iron condor you have to do this for the put side and the call side and then add the credits together.

Calculating Profit Potential and Max Loss on an Options Trade. is a post from Option Selling.
To learn how you too can earn 8-12% Monthly Returns Safely and Conservatively check out OptionGenius.com