Credit Spreads: Spreading The Risky Truth
Today, we're going to talk about how important it is to properly manage your options positions. Credit spreads are one of the most popular option spreads on the market and they say they're a high probability type of trade, but until you experience them first hand, you probably won't understand the risks involved. An options credit spread can be incredibly risky if it is traded alone and not being hedged by any other option position.
The "credit spread" is the first spread learned by most beginners. It is a very simple trade, but as a beginner with option trading you do not realize that this type of trade can be very dangerous. On the internet you will find many courses that teach this way of trading. The real reason is not because it's a safe trade, but it is easy to learn and easy to sell. Teaching "credit spreads" to a beginner in option trading is a great business, but if you only trade "credit spreads," you can lose a lot of money each year. Not only can you lose lots of money, but it is a very stressful way to live. Let's see why.
It's well known that a trader can enter into a credit spread with a 90% probability that they will make money on the trade. This is the popular belief, especially to the beginning option traders, and although it is true, you have to see the whole picture. You know you have a 90% probability to make a profit on your trade, but now you must consider what's happening while the trade is in play. The stress involved in this is not a popular conversation topic for most.
People don't talk about how they can be way behind on the trade sometimes the whole time they're in the trade. People don't talk about how they get down to the very last day and they are risking 90% just to make a small 10%, and they don't talk about how they can't sleep at night and how they are praying to God for their stock to go up tomorrow. Finally, one of the most important things that nobody tells you about the credit spread is that a 90% probability doesn't mean that you're going to make money nine times in a row and then lose one time. The sad truth is that you might lose 90% on your first trade. This happens often to new option traders.
The problem with the credit spread is that it's a very directional trade. Even though it has Theta on its side, it has Delta and Gamma working against it. For the small amount of Theta that you get from a credit spread, you are picking up even more danger by trading this option spread with very high Gamma. What this means is that as the price of the underlying changes, the profit and loss on the trade also changes very quickly. This type of trade is a lot more volatile and risky than most beginning option traders are aware of.
Well to conclude this class on the risk of the credit spread, I'd just like to finish and say that there are many other types of trades that are much safer than this particular option spread. And if you do insist on trading credit spreads, try to combine them with other strategies so they are not so risky.
Article Source: FxTradingStock.com
About the Author
Trade Options, not your livelihood. Learn safer ways to trade options with San Jose Options. Visit now for your free Video!
by: Johnny M Junior
Total views: 72
Word Count: 572
Date: Sun, 23 May 2010
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