After Short Strangles the strategy I like most is Credit Spreads.
Read here how to trade Short Strangles with high probability wins.
Credit Spread is a hedged pair of Options with limited loss and unlimited profit.
Don't pay much attention to the words limited loss and unlimited profit as that does not create realistic picture of the trade. However by definition there is limited loss and unlimited profit.
Credit spread can be traded with either both puts or both calls.
Credit spread is a directional strategy. This means you need to have a directional view for trading this strategy.
For Put side Credit spread the view should be bullish or very bullish
For Call side Credit spread the view should be bearish or very bearish
In the end of this article read the points to understand when to trade Credit Spread and what are do's and don't s
This is how Credit Spread should be traded-
Put Side- (Bullish View)
Sell ATM (at the money) or slightly OTM (Out of the money) Put
Buy further OTM (Out of the money) Put
Let me explain- suppose Nifty is trading near 7600. You feel that Nifty has fallen a lot and trading near its support. Nifty is about to be bottomed out or at-least it will give a bounce of say 200 points from here.
ATM Put (say 7600 Put) will deflate fast as Nifty starts moving up. Sell this Put to earn (collect) the premium.
To protect (hedge) this Put, buy a Put which is further OTM (say 7400 Put)
Premium of 7600 Put (Premium which you receive) is more than premium of 7400 Put (premium which you pay).
So, what you receive, is more than what you pay. Net Credit. Hence the name Credit Spread.
If Nifty expires above 7600, both Options expires worthless (becomes Zero).
What you earn is difference between the premium of both the options.
That is your net profit.
If your view goes wrong and Nifty moves down, the loss is limited.
The 7600 Put (which is sold) starts giving unlimited loss. This is protected by 7400 Put which starts earning unlimited profit.
---------
Call Side- (Bearish View)
Sell ATM (at the money) or OTM (Out of the money) Call
Buy further OTM (Out of the money) Call
Let me explain- suppose Nifty is trading near 8100. You feel that Nifty has seen a good run up and trading near its resistance. Nifty is about to face resistance and can fall by say 200 points from here.
ATM Call (say 8100 Call ) will deflate fast as Nifty starts moving down. Sell this Call to earn the premium.
To protect (hedge) this Call, buy another Call which is further OTM (say 8300 Call)
Premium of 8100 Call (Premium which you receive) is more than premium of 8300 Call (premium which you pay).
So, what you receive, is more than what you pay. Net Credit. Hence the name Credit Spread.
If Nifty expires below 8100 both Options expires worthless (becomes Zero).
What you earn is difference between the premium of both the options.
That is your net profit.
If your view goes wrong and Nifty moves up, the loss is limited.
The 8100 Call (which is sold) starts giving unlimited loss. This is protected by 8300 Call which starts earning unlimited profit.
Read here how to trade Short Strangles with high probability wins.
Credit Spread is a hedged pair of Options with limited loss and unlimited profit.
Don't pay much attention to the words limited loss and unlimited profit as that does not create realistic picture of the trade. However by definition there is limited loss and unlimited profit.
Credit spread can be traded with either both puts or both calls.
Credit spread is a directional strategy. This means you need to have a directional view for trading this strategy.
For Put side Credit spread the view should be bullish or very bullish
For Call side Credit spread the view should be bearish or very bearish
In the end of this article read the points to understand when to trade Credit Spread and what are do's and don't s
This is how Credit Spread should be traded-
Put Side- (Bullish View)
Sell ATM (at the money) or slightly OTM (Out of the money) Put
Buy further OTM (Out of the money) Put
Let me explain- suppose Nifty is trading near 7600. You feel that Nifty has fallen a lot and trading near its support. Nifty is about to be bottomed out or at-least it will give a bounce of say 200 points from here.
ATM Put (say 7600 Put) will deflate fast as Nifty starts moving up. Sell this Put to earn (collect) the premium.
To protect (hedge) this Put, buy a Put which is further OTM (say 7400 Put)
Premium of 7600 Put (Premium which you receive) is more than premium of 7400 Put (premium which you pay).
So, what you receive, is more than what you pay. Net Credit. Hence the name Credit Spread.
If Nifty expires above 7600, both Options expires worthless (becomes Zero).
What you earn is difference between the premium of both the options.
That is your net profit.
If your view goes wrong and Nifty moves down, the loss is limited.
The 7600 Put (which is sold) starts giving unlimited loss. This is protected by 7400 Put which starts earning unlimited profit.
---------
Call Side- (Bearish View)
Sell ATM (at the money) or OTM (Out of the money) Call
Buy further OTM (Out of the money) Call
Let me explain- suppose Nifty is trading near 8100. You feel that Nifty has seen a good run up and trading near its resistance. Nifty is about to face resistance and can fall by say 200 points from here.
ATM Call (say 8100 Call ) will deflate fast as Nifty starts moving down. Sell this Call to earn the premium.
To protect (hedge) this Call, buy another Call which is further OTM (say 8300 Call)
Premium of 8100 Call (Premium which you receive) is more than premium of 8300 Call (premium which you pay).
So, what you receive, is more than what you pay. Net Credit. Hence the name Credit Spread.
If Nifty expires below 8100 both Options expires worthless (becomes Zero).
What you earn is difference between the premium of both the options.
That is your net profit.
If your view goes wrong and Nifty moves up, the loss is limited.
The 8100 Call (which is sold) starts giving unlimited loss. This is protected by 8300 Call which starts earning unlimited profit.
------------
Let take an actual example:
This was traded on 2 Dec 15
Major trend in Nifty was down. However Nifty saw a pull-back rally from 7730 to 7979.
On 2 Dec Nifty was trading near 7930 at closing hours. There was good resistance to Nifty in the range of 7950-8000. My analysis with the help of Demand Supply theory convinced me that Nifty can see some dip from this level (bearish view).
I took this trade:
Sell 8100 Call @ 65.40
Buy 8200 Call @ 38.60
(In this case instead of selling ATM call I went slightly OTM for higher safety)
The premium received (Credit) for one lot of Nifty is as follows:
Premium Received @ 8100 Call= + (65.40*75)= +4905
Premium Paid @ 8200 Call = - (38.60*75)= -2895
Net Premium received = 4905-2895= 2010
As expected Nifty moved down.
On 7 Dec Nifty was trading near 7775.
I felt that I should close the trade as it was making profits of around 3%
Lets see the profit calculations when trade was closed on 7 Dec:
Options prices were as follows:
8100 Call @ 23.30
8200 Call @ 11.80
8100 Call Profit (Which was sold) = (Sell Price - Square Off price)* Lot Size= (65.40-23.30)*75 = 3157.5
8200 Call Loss (Which was bought) = (Buy Price - Square Off price)* Lot Size=(-38.60+11.80)*75 = -2010
Net Profit= 3157.5- 2010= 1147.5
Net premium paid for this pair was 36000 (approx)
% Profit for one lot = 1147.5/36000= 3.18%
This trade has earned 3.18% in only 5 days.
If you are a conservative trader and happy with 2-5% returns per month with a small risk, suitable options strategy is the way out.
I provide advisory for conservative traders / investors who wish to earn relatively safe returns by trading Options. Name of this portfolio is Index Options. Click here to know more.
Lets understand the loss scenario as well:
Had my view went wrong and had Nifty gone up and would have expired say at 8300.
8100 Call Premium = 150 (approx)
8200 Call Premium= 120 (approx)
Loss= (120*75)-(165*75) = 9000-11250 = -2250
This tells us that one loss making trade in Credit Spread can eat up profits of many trades. However, there is always an opportunity to cover up your losses by rolling up the strike prices.
I teach all these practical aspects, in my Options Course. To know more details of the Options Course click here.
Points to Note:
1. Use Credit spreads in extreme case scenario near turning points. (Nifty is too oversold and it is too overbought)
2. If your view goes wrong, losses can be substantial in Credit Spread
3. You can roll the Strike Prices in case Nifty is going against your view
4. Risk Reward Ratio is not very favourable in Credit Spread
5. Demand and Supply theory can be good way to understand the turning points of Nifty.
6. Credit spread gives substantial gains pretty quickly
7 . Margin required in Credit Spread is almost half of what it take for a Strangle
If you trade both the Credit Spreads (Call side and Put Side) at the same time it becomes Iron Condor. Click here to read how to trade Iron Condor.
Hope you like this article.
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