Hi everybody and welcome to this article on credit spreads. In this class today we will be discussing the importance of adjustments and what can happen to you if you do not know how to properly manage your option positions. One of the most popular option spreads on the market is called a credit spread, and we will be looking at this particular spread today. Some people consider this to be a high probability type of trade but until you actually work with this strategy, you may not know or understand the risk involved. An options credit spread can be particularly risky if it is traded alone, meaning that it is not being hedged by any other option position.
The first spread learned by most beginning option traders is the credit spread. It’s a very simple strategy, but what many beginning option traders do not know is that this particular strategy can be very dangerous. There are many courses on the internet that teach this strategy, but the reason is not because it’s a great strategy, but rather, it’s simple, and it’s easy to sell. What I mean to say is that teaching credit spreads to beginning option traders is simply a great business, but the fact is, many option traders who only trade credit spreads lose a lot of money each year. Not only do they lose a lot of money, but it’s also a very stressful way to live. Let me explain why.
It is known that an option trader can go into a “credit spread” with a 90% certainty that he will make money. Most beginners believe in this trade, but if you turn your back to the other side of this picture you may lose big. You need to understand what is happening while this trade is in play. People will not tell you about the high stress that is involved with just trading an option “credit spread”.
There are times you can be behind in your trade the entire time you are in the trade, but the teachers will not tell you that. They do not talk about how they really feel, how worried they are, how difficult it is to sleep, all the way to the very last day, and praying for their stock to go up the next day. You are really putting at risk 90% of your money to make a small 10% profit. The truth is you may lose 90% with your first trade. No one tells you that with the “credit spread.” A 90% probability does not mean you will make money nine times in a row and then lose one time. You may lose it all the first time. This does happen with beginning option traders.
The “credit spread” is a very directional trade and this is the problem. Even though it has Theta on its side, it has Delta and Gamma working against it. For the little amount of Theta that you get from a credit spread, you are picking up more danger by trading this option spread with very high Gamma, because when the prices of the underlying changes, the profit and loss on the trade will also change very fast. This type of trade is a lot more volatile and high risk than most beginning option traders are aware of.
In ending this class on the high risk in “credit spreads”, I would just like to say that there are many other types of trades that are much safer than this “option spread”. If you do trade “credit spreads”, please try to combine them with other trades so they are not so risky.