Option Credit Spreads: Risk-Adverse Strategy for Monthly Income
Stock options have a well-deserved reputation for being a “high risk” speculation that more often than not loses money over the long run.
That assessment is a fair one based on how most option traders operate; they buy options outright and hope for a move in the underlying stock that is big enough, and occurs fast enough, to overcome the premium they paid for the options and the inexorable time decay that erodes the value of options as time passes.
Option credit spreads, however, are a much lower risk option technique that conservative pros and savvy amateur investors use to generate a stream of income each month, no matter which way the market goes. In effect, the seller of an option credit spread collects the premiums the outright option buyers are paying! Not surprisingly, time decay is working for the credit spread investor and the statistics indeed favor the credit spread investor over outright buyers of options.
Why Option Credit Spreads Are So Attractive for Risk-Adverse Income Investors
1. They are non-directional, which means the investor does not have to correctly predict the short-term direction of the market in order for his option credit spread to produce the maximum profit.
2. As indicated earlier, options must lose value as time passes and the option nears expiration day. That’s an enormous problem for the option buyer, but it is exactly what the option seller (as with credit spreads) desires.
3. As with buying an option, the maximum risk associated with the trade is known in advance. In the case of option credit spreads, it is based on the interval between the two options that comprise the spread. One of the benefits of options credit spreads is that, if the trade is going against the investor, he has a number of trade adjustment steps he can take to minimize the potential loss on the trade or even turn it into a profit.
4. Properly selected and managed credit spreads can routinely produce an 80%+ ratio of winning trades to losing ones.
5. The high proportion of successful trades, coupled with a disciplined risk management approach that keeps the inevitable occasional losing trade a relatively small loss, results in a
4.0 – 8.0% PER MONTH rate-of-return on investment (margin) a reasonable target.
As with any investment vehicle, the trader who is seriously interested in producing serious growth in his account should not rush into option credit spreads before he fully understands how to identify the most attractive credit spread candidates and how to manage his positions once they are established.
Do your homework!