In “The Top 3 DEADLIEST Credit Spread Mistakes To Avoid!” video by Options with Davis, you will learn about the top three credit spread mistakes to avoid in trading. The video aims to provide solutions and advice for traders who are not consistently profitable in trading credit spreads. One of the main points discussed is the risk of holding credit spreads until expiration, which can lead to early assignment and additional risks. The video also emphasizes the importance of considering wider spread widths and avoiding going naked to minimize risk and protect capital. By watching this video and implementing the strategies shared, you can avoid these deadly credit spread mistakes and improve your trading success.
In the video “The Top 3 DEADLIEST Credit Spread Mistakes To Avoid!” by Options with Davis, you will discover the three most dangerous mistakes that traders make when trading credit spreads. One of these mistakes is holding credit spreads until expiration, which can result in early assignment and increased risks. The video also highlights the risks of trading with tight spread widths and going naked. By avoiding these mistakes and following the advice provided, you can protect your capital and increase your profitability in credit spread trading. Don’t miss out on this valuable information that can improve your trading skills and success.
Mistake #1: Holding credit spreads until expiration
When it comes to trading credit spreads, one of the deadliest mistakes you can make is holding them until expiration. There are several reasons why this is a risky move.
Potential early assignment
One of the risks of holding credit spreads until expiration is the potential for early assignment. Let’s say you have a put credit spread and the market moves against you, causing the short options to become in-the-money. In this scenario, there is a chance that the options could be assigned early, leaving you with a long position of 100 shares. This can create confusion and potentially disrupt your spread. Additionally, if you do not have the capital to cover the assignment, you may be required to deposit more funds into your account. Early assignment can be an unexpected event that adds complexity to your trading strategy.
Additional risks
Another reason why holding credit spreads until expiration is a mistake is because it exposes you to additional risks. For example, if you have a call credit spread and the underlying stock pays a dividend, there is a possibility of getting assigned early. This would result in you being short 100 shares of the stock, which can be a risky position if the stock price continues to rise. By holding the spread until expiration, you are potentially exposing yourself to unnecessary risks that could be avoided by closing the position earlier.
Mistake #2: Trading with tight spread widths
Another deadly mistake in credit spread trading is using tight spread widths. While it may seem tempting to trade with narrower spreads, it can actually lead to negative consequences.
Higher commissions
One drawback of trading with tight spread widths is the higher commission costs. When you increase the number of contracts to compensate for the narrower spread width, you are essentially increasing your exposure and the number of transactions you need to make. This can result in higher commission fees, eating into your overall profits.
Lower probability of profit
Additionally, trading with tight spread widths often leads to a lower probability of profit. By narrowing the range between the short and long strikes, you are reducing the potential profit zone and increasing the chances of the underlying stock moving against your position. This decreases the likelihood of your spread expiring out-of-the-money and results in a lower probability of profiting from the trade.
Higher risk
Lastly, trading with tight spread widths increases your overall risk. Since the potential profit zone is smaller, any adverse movement in the stock price can have a significant impact on your position. This can lead to larger losses and a higher level of risk compared to trades with wider spread widths.
Mistake #3: Going naked or converting a credit spread into a naked position
One of the riskiest mistakes you can make in credit spread trading is going naked or converting a credit spread into a naked position. This involves removing the long option from the spread, leaving only the short option exposed.
Significantly increased risk
Going naked or converting a credit spread into a naked position significantly increases your risk exposure. Without the protection provided by the long option, you are now fully exposed to the potential losses associated with the short option. This means that if the price of the underlying stock moves against your position, your losses can be substantial. The risk of going naked is not recommended for inexperienced traders or those with limited capital.
Tied up capital
Another drawback of going naked is that it ties up your capital. By removing the long option from the credit spread, you are no longer able to utilize that capital for other trades or investment opportunities. This lack of flexibility can limit your ability to take advantage of new market conditions or potential profit opportunities.
Potential account blow-up
Perhaps the biggest risk of going naked is the potential for your account to blow up. Without the protection of the long option, a significant adverse move in the stock price can lead to unlimited losses. This can wipe out your trading account and create financial hardship. It is important to understand the risks involved before considering going naked in credit spread trading.
Solution #1: Exit credit spreads at 21 DTE
To avoid the risks associated with holding credit spreads until expiration, it is recommended to exit the position at 21 DTE (Days to Expiration). This strategy allows you to manage your trades proactively and minimize potential problems.
Understanding DTE
DTE stands for Days to Expiration and refers to the number of days left until the options contract expires. By tracking the DTE, you can better plan your exit strategy and avoid the potential risks associated with holding a credit spread until expiration.
Benefits of exiting at 21 DTE
Exiting credit spreads at 21 DTE offers several benefits. Firstly, it helps reduce the risk of early assignment. By closing the position before the options are likely to be in-the-money, you can avoid the uncertainty and potential capital requirements associated with early assignment. Additionally, exiting at 21 DTE allows you to lock in profits or minimize losses more effectively. It provides greater control over your trades and allows for more efficient capital allocation.
Solution #2: Consider wider spread widths
To mitigate the negative impact of trading with tight spread widths, it is advisable to consider using wider spread widths in your credit spread trades.
Definition of spread width
Spread width refers to the difference between the short and long strikes in a credit spread. By increasing the spread width, you can expand the potential profit zone and reduce risk exposure.
Advantages of wider spread widths
Trading with wider spread widths offers several advantages. Firstly, it can lower commission costs. With wider spreads, you need fewer contracts to achieve the desired exposure, reducing the number of transactions and associated commission fees. Secondly, wider spread widths increase the probability of profit. By giving the underlying stock more room to move before reaching the short strike, you improve the chances of the spread expiring out-of-the-money. Finally, wider spreads decrease overall risk. The larger profit zone provides a cushion against adverse price movements, reducing potential losses and risk exposure.
Solution #3: Avoid going naked
To protect your capital and minimize risk, it is crucial to avoid going naked or converting a credit spread into a naked position.
Explanation of going naked
Going naked involves removing the long option from a credit spread, leaving only the short option exposed. This significantly increases risk exposure and should be avoided, especially by inexperienced traders.
Risks involved
By going naked, you are fully exposed to potential losses from adverse price movements. Without the protection provided by the long option, your account is at risk of suffering substantial losses. This strategy is not recommended for traders who are not experienced or well-capitalized.
Importance of protecting capital
Protecting your capital is essential for long-term trading success. By avoiding the temptation to go naked, you preserve your capital and maintain the ability to take advantage of new opportunities in the market. Protecting your capital allows for better risk management and increases your chances of consistent profitability.
Advice for traders who have made these mistakes
If you have made any of the previously mentioned mistakes in your credit spread trading, here are some actions you can take to rectify the situation.
Evaluate the impact
First and foremost, evaluate the impact of the mistake on your trading performance. Assess the losses incurred, the potential risks you faced, and the impact on your overall account balance. Understanding the extent of the mistake will help you devise a plan to address it effectively.
Adjust strategies moving forward
Learn from your mistakes and make adjustments to your trading strategies moving forward. Integrate the solutions provided in this article to avoid repeating the same errors. Consider implementing risk management strategies, such as exiting credit spreads at 21 DTE and using wider spread widths, to protect your capital and increase your chances of profitability.
Minimize risk exposure
Lastly, focus on minimizing your risk exposure in future trades. This can be achieved by diversifying your portfolio, setting clear risk management rules, and continuously monitoring your positions. By being proactive and disciplined in managing risk, you can improve your overall trading performance and avoid costly mistakes.
Free copy of ‘The Options Income Blueprint’
As a helpful resource, Options with Davis offers viewers a free copy of “The Options Income Blueprint.” This book provides valuable insights and strategies for trading credit spreads and generating consistent income.
About the book
“The Options Income Blueprint” is a comprehensive guide to trading credit spreads and maximizing your income potential. It covers key concepts, risk management techniques, and practical strategies for successful credit spread trading. Whether you are a beginner or an experienced trader, this book offers valuable information to help you improve your trading performance.
How to access the free copy
To access a free copy of “The Options Income Blueprint,” follow the instructions provided by Options with Davis. Visit the specified website or platform and follow the steps to obtain your free copy. Make sure to take advantage of this opportunity to enhance your knowledge and skills in credit spread trading.
Other related videos by Options with Davis
Options with Davis offers a series of related videos for viewers’ interest. These videos cover various topics related to credit spreads and provide additional insights and strategies.
Video 1: Introduction to credit spreads
In this video, Options with Davis provides an introduction to credit spreads. The video covers the basics of credit spread trading, including the concept of risk and reward, selecting strike prices, and managing positions.
Video 2: Advanced credit spread techniques
Building upon the foundational knowledge from the first video, this second video delves into advanced credit spread techniques. Options with Davis explores topics such as adjusting positions, managing risk, and maximizing profitability in credit spread trading. This video is perfect for traders looking to take their credit spread trading to the next level.
Video 3: Case studies and real examples
In the final video of the series, Options with Davis presents case studies and real-life examples of credit spread trades. By studying these examples, you can gain practical insights into how credit spreads can be implemented and managed in different market scenarios. This video provides valuable lessons that can be applied to your own trading strategies.
Conclusion
In conclusion, avoiding the top three deadliest credit spread mistakes is crucial for successful trading. By recognizing the risks associated with holding credit spreads until expiration, trading with tight spread widths, and going naked, you can protect your capital and minimize risk exposure. Utilizing the provided solutions, including exiting credit spreads at 21 DTE, considering wider spread widths, and avoiding going naked, will lead to more effective and profitable credit spread trading strategies. Remember to evaluate the impact of past mistakes, adjust your strategies, and prioritize risk management to achieve consistent profitability in credit spread trading.