A Vertical Put Credit Spread is a strategy put in place by buying a put at a strike price of, let's say $50 and then selling a put at $55 for the same month as the purchased put. In this scenario the current price is $56, so what you are achieving by placing these two trades is a net credit. Therefore you effectively receive your potential profit at the start of the trade because the price you bought the put was less than the premium you received from selling the put at a higher strike price. However keep in mind that since your broker will most likely mark the position to market constantly, you cannot spend the net credit received.
This strategy is used is when you believe an underlying security will rise, remain neutral, or fall slightly. If this is the case, then the puts will expire worthless since they will be out of the money. Therefore the spread between the prices of the two puts becomes zero. As time passes and the probability that the puts will be worthless increases, the spread will move towards zero. This works in your favour as you have sold the spread at a price greater than zero.
With the puts remaining out of the money and the spread narrowing to zero, your position will increase in value each day, holding all other factors the same. The change in the value of a position with time is often referred to as “Theta”. Therefore this trade carries positive Theta as the time premium on the puts decays and the spread between the two prices moves to zero. Taking advantage of this positive theta is only possible if both options are out of the money and remain out of the money until the options expire.
The potential profits in this trade are limited to the initial net credit, which is the difference between the premium received from selling the puts and the price paid to buy the puts. Although the potential profits are limited, the potential losses are also limited. The maximum loss is the difference between the two strike prices minus the initial net credit received, multiplied by the deliverable shares in each put, and then times the number of contracts involved in each leg of the spread.
This strategy is different from simply buying calls because it does not rely on large percentage moves in the underlying asset. It requires that you pick the correct direction and the future volatility of the underlying security. It also differs because selling a vertical put credit spread will produce positive Theta, whereas simply buying a call option will generate negative Theta.
An example of SK OptionTrader using this options strategy was on 27th of March 2011. This was achieved by selling SPY May 21 '11 $126 puts for $1.61 and buying the $125 puts for $1.43 which resulted in a net credit of $0.18. SK OptionTrader signalled this trade to subscribers after analysing bullish technical signals from the MACD on SPY (SPY is an ETF that tracks the S&P 500). On the fundamental side, SK OptionTrader believed that markets had sold off too steeply after the tragic Japanese earthquake. The trade was closed on the 18th of May for an 18% profit in 54 days. Click here to read more details on this trade.
Another example of SK OptionTrader using this strategy effectively was in 2010. SK OptionTrader believed that gold gains would be limited over the next month (after taking huge profits on call options during the previous months).
Therefore SK OptionTrader signalled to subscribers to enter into a bullish vertical credit spread on the 13th of December and then two more on the 16th of December. All 3 of these trades expired on January 22 with gains of 13%, 13% and 17%.
This strategy was also effectively used in two other trades. The first of these two was a 15% gain over 17 days after SK OptionTrader signalled to subscribers that the rally in US Treasuries was overdone and that yields, particularly at the long end of the curve, were too low.
Finally SK OptionTrader made subscribers further profits when we signalled to our subscribers to sell GLD August 2011 $140 puts and buy $139 puts, resulting in a net credit of $0.20. As expected, on the 20th of August the puts expired worthless, which resulted in the trade having a 20% gain over just 22 days!
Being able to use this and many other options strategies effectively increases ones versatility in the market. Also using these strategies allows traders to place trades that more accurately represent their market views, which when correct, can lead to much higher profits.
Currently the SK OptionTrader model portfolio is up 407.38%, which means a $10000 portfolio invested in accordance with SK OptionTrader signals would now be worth $50,738.14. On average a position gains 42.43% in 45.85 days, which provides an annualized return of 113.83%. So now is the perfect time to open a subscription with SK OptionTrader and begin increasing the profitability of your options trading portfolio.
For those subscribers who are too busy to trade their own accounts we are now able to offer Autotrading programs with our SK OptionTrader service. One can sign up for autotrading with Global AutoTrading or eOption.
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