Understand the Risks Associated with Weekly Credit Spreads
Weekly credit spread is a popular option trade strategy. For beginners, credit spread means to sell one option and simultaneously buy another one for protection.
The sold OTM option has high premium rate than the purchased one. The premium difference between both generates credit in your trade account, which can be kept if option expires OTM or worthless. Let’s understand it more clearly with an example.
Stock price of Macrosh Company is $50. You predict the stock price to move in upward direction. In addition, you don’t desire to tie too much cash in buying stock, so you plan to invest in weekly options to sell OTM put.
- Sell $38 put for $0.60 credit
- Buy $36 put for $0.30 debit
The difference between sell and buy put is –
$0.60 credit – $0.30 debit = $0.30 credit or profit/spread
If stock closes below $38 sell and below $36 put then the risk generated is –
$38 – $36 = $200 loss – $30 credit you gained from selling spread is equal to $170. This is the maximum loss.
In weeklies, you see decay erosions almost instantly because each week is expiration week. On the other hand, on monthly options you may not see time erosion because the credit spread expires after four weeks [assuming stock price has not changed much].
Bull put credit spreads
If the chosen stock is assumed to be bullish then you can generate high credits by writing a spread closer to its price. For example, if Macrosh Company stock is $50 and you assume it to sit and not move then place credit spread at $52 put and buy at $48 put for getting huge credit.
If stock does not bounce in a week, as assumed then sell ITM put option and roll spread to the next week or even buy the stock.
Bearish call credit spreads
If you feel bearish about a stock and assume it won’t budge any higher then sell closer and buy higher to gain a combined payment credit. It is a bit risky than the put option because overtime stock has a tendency to move higher. So, if short call performs against you then you lose.
Weekly credit spreads are flexible
Credit spreads are popular weekly options strategy because you keep on writing new spreads each week. If stock moves against your presumption then you can roll same spread easily to next week until stock retracts or rolls higher. Weekly options offer income traders flexibility because their aim is to generate rapid time decay.
Understand and take care
Monthly options sell at high premiums because they have long life but weeklies have short expiration time, so traders need to place trades closer to strike prices for gaining decent credit premiums. Therefore it becomes necessary to manage weekly option trades more carefully then monthly options, especially when the stock involves fluctuates a lot.
Weekly credit spread options are simple and consistent. They lull you into feeling safe and secure, but actually are too aggressive and volatile.
For earning significantly every week risk is a must!