In the video titled “Credit Spreads – The FASTEST Way To Grow A Small Account” by Options with Davis, you’ll learn about the effectiveness of credit spreads in growing a small trading account. With a free download of the Options Income Blueprint, Davis explains how credit spreads provide a high probability trade setup for small accounts. The video covers the mechanics of bull put spreads and bear call spreads, including tips on trade management and profit-taking strategies. Davis also provides trade examples using the iShares Russell 2000 ETF and discusses the advantages of credit spreads over naked option strategies. Overall, this video offers valuable insights on using credit spreads to efficiently grow a small trading account.
Benefits of Credit Spreads
Fast way to grow a small trading account
Credit spreads are a popular option strategy for traders with small account sizes. They offer a fast way to grow these accounts due to their high potential for profitability. By utilizing credit spreads, traders can take advantage of the time decay of options and generate income, even with limited funds. This allows for capital growth and the ability to compound gains over time.
High probability trade setup
One of the main advantages of credit spreads is their high probability of success. By selling options with a higher strike price and buying options with a lower strike price, traders can create a spread that benefits from time decay and limited risk. This gives them a higher probability of profiting from the trade, as the underlying asset only needs to stay within a specific range for the spread to be profitable.
Time decay increases profitability
Time decay, also known as theta decay, is a crucial factor in credit spreads. As time passes, the value of options decreases, which works in favor of the trader who sold the options. This time decay increases the profitability of credit spreads, as the spread’s value decreases over time. Traders can take advantage of this by holding the spread until expiration or taking profit at a predetermined time.
Limits risk and allows for proper position sizing
Credit spreads offer defined risk, as the maximum loss is limited to the width of the spread minus the credit received. This allows traders to better manage risk and protect their capital. Additionally, credit spreads allow for proper position sizing, which is especially beneficial for traders with small accounts. By controlling the size of the spread, traders can ensure that their risk is proportionate to their account size, reducing the potential for significant losses.
Understanding Credit Spreads
Premium selling strategies
Credit spreads are premium selling strategies, which means that traders profit by selling option premium. This involves selling options with a higher strike price and buying options with a lower strike price. The premium received from selling the options offsets the cost of buying the options, resulting in a net credit. This net credit represents the potential profit for the trade.
Semi-directional bet in the market
Credit spreads allow traders to take a semi-directional bet in the market. Instead of needing the underlying asset to move significantly in one direction, traders only need the asset to stay within a specific range for the credit spread to be profitable. This flexibility gives traders more opportunities to profit, regardless of the market’s overall direction.
Types of credit spreads: bull put spreads and bear call spreads
There are two main types of credit spreads: bull put spreads and bear call spreads.
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Bull put spreads involve selling an out-of-the-money put option and buying a further out-of-the-money put option to hedge risk. This strategy is used when a trader has a bullish outlook on the market and believes that the underlying asset will not fall below a certain price.
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Bear call spreads involve selling an in-the-money call option and buying a further out-of-the-money call option to define risk. This strategy is used when a trader has a bearish outlook on the market and believes that the underlying asset will not rise above a certain price.
Both strategies benefit from time decay and offer defined risk, making them popular choices for traders looking to profit from options premium.
Managing Credit Spreads
Different methods of managing credit spreads
There are several methods that traders can use to manage credit spreads effectively. These methods allow traders to maximize profits and minimize losses. The key is to have a clear plan in place and stick to it throughout the trade.
Taking profit at 50%
One method of managing credit spreads is to take profit when the trade has reached 50% of its maximum potential profit. This allows traders to lock in gains and protect their capital. By exiting trades at this point, traders can ensure that they capture a significant portion of the expected profit.
Holding until expiration
Another method is to hold the credit spread until expiration. This allows traders to extract the maximum potential profit from the trade. However, holding until expiration can be riskier, as there is always the possibility that the trade goes against the trader. It is essential to assess market conditions and the underlying asset’s behavior before deciding to hold the spread until expiration.
Closing at 21 days to expiration
Closing credit spreads at around 21 days to expiration is a common approach. At this point, the spread’s value begins to decline rapidly due to time decay. By closing the trade at this time, traders can capture a significant portion of the expected profit and reduce the risk of the spread moving against them.
Holding until trade goes outside breakeven point
Some traders choose to hold credit spreads until the underlying asset moves outside the breakeven point. This approach allows traders to give the trade more room to develop and potentially turn profitable. However, it also carries a higher risk, as the trade may result in a loss if the asset moves unfavorably. Proper risk management and assessment of market conditions are crucial when employing this strategy.
Trade Examples with iShares Russell 2000 ETF
To illustrate the potential of credit spreads, let’s examine some trade examples using the iShares Russell 2000 ETF (IWM). These examples will demonstrate how credit spreads can generate profits in different market conditions and highlight the importance of trade management.
Profit taken in a short amount of time on first trade
In the first trade example, a credit spread is placed on IWM when the market is showing signs of oversold conditions. The trader sells an out-of-the-money put option and buys a further out-of-the-money put option to hedge risk. Due to the time decay of options, the trade becomes profitable in a short amount of time. The trader takes profit and locks in gains, benefiting from the high probability trade setup provided by credit spreads.
Holding trade to expiration could result in loss or higher profit
In another trade example, the trader decides to hold the credit spread on IWM until expiration. This trade demonstrates the potential risks and rewards of holding credit spreads until expiration. Depending on the market movement, the trade could result in a loss or a higher profit compared to exiting the trade earlier. It showcases the importance of assessing market conditions and potentially adjusting the trade management strategy accordingly.
Using oversold conditions to place short put spread trade on IWM
Next, a short put spread trade is placed on IWM, taking advantage of oversold conditions in the market. By selling an out-of-the-money put option and buying a further out-of-the-money put option, the trader hedges risk and benefits from time decay. The trade becomes profitable due to the market’s recovery and the time decay of the options, showcasing the effectiveness of credit spreads in these conditions.
Short put spread trade on SPY placed below previous low
In another example, a short put spread trade is placed on the SPDR S&P 500 ETF (SPY) below a previous low. This trade demonstrates the flexibility of credit spreads, as they can be used on various stock ETFs regardless of price. Despite the market initially going against the trade, the spread and proper trade management still allow the trader to achieve a profit. This showcases the potential of credit spreads even in challenging market conditions.
Bearish Credit Spread Trades
Using overbought conditions to place trades on IWM and SMH
In bearish market conditions, credit spread trades can also be profitable. By analyzing overbought conditions, traders can identify opportunities to place bearish credit spread trades. This involves selling in-the-money call options and buying further out-of-the-money call options to define risk. By taking advantage of market indicators, such as overbought conditions, traders can increase their chances of making a profit from these bearish credit spread trades.
Profit achieved on both trades before expiration
The bearish credit spread trades placed on IWM and the VanEck Vectors Semiconductor ETF (SMH) in overbought conditions prove to be successful. The options’ time decay and the underlying assets’ movement within the predicted range allow the spreads to reach their maximum potential profit before expiration. Proper trade management, such as taking profit at the right time, contributes to the profitability of these trades.
Following trade management guidelines
Throughout these bearish credit spread trades, following trade management guidelines is essential. Proper position sizing, placing the trades in overbought conditions, and assessing market indicators all contribute to the success of these trades. Traders should always have a clear plan and stick to it to manage risk effectively and maximize profits.
Trade Examples: SMH, CRM, and Short Call Spread
To further illustrate the potential of credit spreads, let’s examine three trade examples: the VanEck Vectors Semiconductor ETF (SMH), salesforce.com Inc. (CRM), and a short call spread trade.
Good setup in CRM due to previous highs and overbought conditions
In the trade example using CRM, the trader identifies a good setup based on previous highs and overbought conditions. By recognizing these market indicators, the trader can place a credit spread trade that takes advantage of time decay and limited risk. The trade becomes profitable in just nine days, showcasing the potential of credit spreads in these favorable market conditions.
Profit obtained in nine days
The credit spread trade on CRM results in a profit within a short timeframe. This quick profit-taking demonstrates the efficiency and effectiveness of credit spreads in generating income. When combined with proper trade management, credit spreads can provide traders with consistent profits over time.
Positive expectancy in the long term
The trade examples shown throughout the article demonstrate the positive expectancy of credit spreads in the long term. While individual trades may result in losses, overall, credit spreads offer a high probability of success. By following the guidelines and strategies discussed, traders can increase their chances of generating consistent profits over time.
Advantages of Credit Spreads
Credit spreads offer several advantages for traders, especially those with small accounts. These advantages contribute to their popularity and effectiveness as a trading strategy.
Defined risk
One of the main advantages of credit spreads is the defined risk they offer. The maximum loss is limited to the width of the spread minus the credit received. This allows traders to control their risk and protect their capital, making credit spreads a suitable strategy for those looking to manage risk effectively.
Suitable for small accounts and proper position sizing
Credit spreads are particularly beneficial for traders with small accounts. They offer the opportunity to grow these accounts quickly due to their high potential for profitability. Additionally, credit spreads allow for proper position sizing, ensuring that the risk is proportionate to the account size. This enables traders to manage their capital effectively and prevent significant losses.
High probability option strategy
Credit spreads provide a high probability trade setup, increasing the likelihood of success for traders. By structuring trades with a high probability of profit, traders can increase their chances of generating consistent income. This reliability makes credit spreads an attractive option strategy for many traders.
Profit can be made even if direction is wrong
One unique aspect of credit spreads is the ability to profit even if the market moves against the trader’s original direction. As long as the underlying asset stays within a certain range, the credit spread can still be profitable due to time decay and limited risk. This flexibility allows traders to profit from a variety of market conditions, increasing the potential for success.
Can be used on any stock ETF, regardless of price
Another advantage of credit spreads is their versatility. They can be used on any stock ETF, regardless of price. This allows traders to apply credit spreads to a wide range of assets and take advantage of different market conditions. The flexibility and accessibility of credit spreads make them a valuable tool in any trader’s arsenal.
Comparison to Naked Option Strategies
Credit spreads offer several advantages compared to naked option strategies, particularly when it comes to risk exposure and capital requirements.
Buying power kept at spread width
One significant advantage of credit spreads is that they keep buying power at the spread width. This means that traders do not need to tie up a large amount of capital to place the trade. By defining the risk and limiting the buying power required, credit spreads provide traders with more flexibility and the ability to deploy their capital more efficiently.
Less risk exposure
Compared to naked option strategies, credit spreads offer less risk exposure. With naked options, the potential losses can be significant and even unlimited, depending on the direction of the market. Credit spreads, on the other hand, have defined risk, limiting the maximum loss to the width of the spread minus the credit received. This controlled risk allows traders to manage their capital more effectively and protect themselves from significant losses.
In summary, credit spreads are a fast and effective way to grow a small trading account. With their high probability trade setups, time decay advantages, risk limitation, and proper position sizing capabilities, credit spreads offer traders a powerful tool for generating consistent profits. By understanding the mechanics of credit spreads, implementing effective trade management strategies, and utilizing trade examples, traders can take advantage of this versatile option strategy and enhance their trading success.