*The investment results described in this testimonial are not typical. Investing in securities carries a high degree of risk; you may lose some or all of the investment.
The Optimal Time Until Expiration
Each option has an expiration cycle that can be weekly, monthly, quarterly, or annually.
We want to focus on the monthly expiration cycles for highly liquid stocks like Apple (AAPL), IBM (IBM), and so on.
If you pull up an options chain for a symbol and you only see monthly options, chances are the stock isn't liquid enough.
Ideally, we want to create trades that are between 30 and 60 days until expiration, with the optimal length of time being 45 days until expiration.
Selling option credit spreads in that range creates the ideal balance of time decay and directional risk.
This is the options chain for Tesla (TSLA):
Source: Thinkorswim
As one of the most widely traded stocks, TSLA has weekly and monthly options.
So, how do I choose an expiration cycle? I look for the best balance of directional risk and time decay. In this case, I'd choose the expiration cycle 52 days out, or the April 14, 2022, expiration. I also want to consider when a company reports earnings.
Tesla last reported earnings on Jan. 26. The next earnings release is estimated to happen between April 25 and May 3.
That's outside of the monthly expiration, which is what I want to see.
I don't want to take on the directional risk from an earnings announcement that can send a stock moving in one direction or another.
By the way, a benefit of using options with exchange-traded funds (ETFs) is that you never have to worry about earnings. While you do have to take dividend payments into account, as you would with any stock, they tend not to have a material impact unless you are at expiration and at the money.
Managing Your Trade to 50% of Max Profit
Ideally, you want to close the trade at 50% of your maximum potential profit. Why? Because it increases our win rate and returns our capital back to us faster to be redeployed for another trade.
What's really cool is you can do this right after you initiate the trade.
Let's use Tesla again for our example.
Source: Thinkorswim
Assume I put on a call credit spread selling the $870 strike and buying the $875 strike.
That would result in the following:
$73.65 - $70.16 = $3.49 credit and my maximum potential profit
$875 - $870 - $3.49 = $1.51 is my maximum potential loss
If $3.49 is my maximum potential profit, once I got filled on the trade, I could immediately turn around and set a closing order for $3.49/2 = $1.75.
Here's how that would work:
I sell to open the $870/$875 call spread for a $3.49 credit.
The order of the option strikes doesn't matter when you write it out for another trader. All that matters is you identify it as a call credit spread or that you received a credit. The other trader will automatically know that if it's a credit spread or you received a credit, you sold the lower strike and bought the upper strike.
I immediately create a good 'til canceled order to buy to close the $870/$875 call spread for $1.75.
In options lingo, "open" means initiating the trade. "Close" means exiting the trade. If you sell something, it means you will receive a credit. If you buy something, it means it will cost you a debit.
By placing the closing trade immediately after I initiate the position, I simplify my trade management.
Managing Your Trade at 21 Days Until Expiration
Not every trade works out the way we want it to.
Sometimes we don't hit that 50% of maximum profit, or our trade moves against us.
At 21 days until expiration, we hit an inflection point. That's the time where the balance tilts in favor of directional risk and away from time decay.
So, here's what you can do.
At 21 days until expiration:
If your credit spread is at breakeven or a profit, close out the trade and move on.
If your credit spread is at a loss, and you can roll the trade to the next monthly expiration cycle for a credit, as long as the implied volatility rank is over 30.
If your credit spread is at a loss, and the implied volatility rank is below 30 or you cannot roll the trade for a credit, let it ride until you can take it off at breakeven or just before expiration.
Despite taking six years and $5 million to develop, the “Money Dial” is SUPER easy to understand.
The higher a company registers on the “Money Dial,” the more public interest there is in that company's products or services. Which means, potentially higher sales and an even higher price hike on the stock itself. Right now, three companies are registering over 90 on the “Money Dial.”
Since credit spreads are defined-risk trades, they become mechanical without much need for management.
Most of the time they either work or they don't. It's the little things we do, like selling credit spreads when implied volatility is high and managing our winners at 50%, that give us an edge.
This is quite different from naked options strategies like strangles and straddles, where traders need to aggressively manage their positions.
That's why I like option credit spreads. They're easy to understand, implement, and manage.
Now that you've learned a bit about option spreads, what stocks and sectors do you think are great places to try option credit spreads and why? Email me and let me know. While I can't respond to everyone individually, I promise to read every message.
Enjoy your day,
Keith Kaplan CEO, TradeSmith
P.S. The Money Dial has identified 138 opportunities in the market that have delivered gains more than five times greater than the S&P 500.
It has the power to predict stocks primed for the biggest gains, because it measures goods and services people actually want to buy.
The Money Dial taps into public demand to figure out what products they'll buy and what trends they'll support.
For complete details on how it isolates likely winners, click here.
Best of TradeSmith
The chart below represents the best-performing open positions over the last two years, as recommended by our software.
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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