Credit spreads are a very simple trade.
You sell one option, buy another for protection and hope that your sold option is not in the money on expiration day.
In other words you sell the 100 put and hope the stock stays above 100. Or sell the 150 Call and hope the stock stays below 150.
And since credit spreads have such a high probability of profit, most traders make money with them most of the time. But when they lose….. ouch. Credit spreads are not very forgiving when you lose.
I learned this firsthand. I had been trading credit spreads in Apple, FXI, and Google. Doing well for several months in a row. But then there was a drop, and all the gains I had made, plus a lot more was wiped out.
It takes a while to recover mentally from a loss like that. I was reminded of this event when a member emailed me his credit spread horror story yesterday which he gave me permission to share with you.
Keep in mind that this member has been trading for 17 years so he is not new to the game.
“I now try to follow a strategy I read last year in the book of Proverbs from the Bible, of all places: it says:
” … whoever gathers money little by little makes it grow.”
I was shooting for 1 or 2% per Week with Weekly options. It does not souund like a lot and takes a long time – but after 1 year, it is 50 – 100% for the year, which is great. It is like your 5% per month strategy. Making a little money on lower risk option credit spreads over and over again adds up over time.
Yes whatever you do – NEVER CHANGE your Strategy if it has proven to work. – and NEVER get greedy. When you make your 5% or so – get out. Do not try to get more. Every time I do that, I end up loosing the 5% and then loosing even more. I just lost $3,500 on a NETFLICKS Credit spread 2 Friday’s ago (a weekly position), in the last 45 Min, when NETFLICKS spiked up 8 points in that final 45 min after being flat the entire day. I went from a $200 gain to a $3,500 loss – all in that 45 min – going into the close (Expiration Friday). I was so devastated. it will take me months to recoup that – as soon as I get up the nerve to start trading again.
Urgh, I was so, so destroyed by that one trade. Prior to that trade, I hade made 29 out of 30 trades over the past 3 months – all making about $150 each (ie, “little by little”). Then BANG – all gone in 45 min.”
So as I mentioned, credit spreads can hurt if they go against you. Add the high gamma of weekly options and you can be broke in a few hours. I know that weeklies have become very popular. But they are very risky.
Before you play the weeklies, I would suggest you get good at the regular monthly option trades and know exactly how and when you will adjust or exit. Once you have some consistent winners, then try the weeklies.
Weeklies are not the holy grail they have been made out to be. Use them with caution.