A Credit Spread: Is The Popular Option Trade Really a Mirage?
The Truth About High Probability Credit Spreads with Options
OTM Credit spreads are one of the most popular instruments used in Option Trading. The question is why. The answer is simple. The OTM credit spread is the easiest spread to understand for beginning option traders. Next question: does this make it a good strategy?
The truth is that OTM Credit Spreads have a high probability of making a profit. However, along the way to realizing a gain with this trade, you have a lot of risk and stress involved. For example, the average Credit Spread trader will face 100% losses on this trade several times a year while trying to make a modest 5 to 10% a month. What happens is that eventually most Credit Spread Traders meet their doomsday. Sooner or later, virtually all option traders who use only OTM Credit Spreads wipe out their trading accounts.
Let’s look at the “Computer Glitch” of 2010 when the DOW dropped 1000 points in a matter of minutes. Those doing Credit Spreads on this day lost on average between 70% and 90% of their portfolio. What happened is that the volatility rose drastically and the trades moved into that “danger zone” where they lose 100% 10 percent of the time. The Credit Spread trader doesn’t realize that the 10 percent of the time they lose can happen AT ANY TIME. Most people think that they will have 9 wins followed by 1 loss, but this obviously is not how the law of probability works. It’s not uncommon for an OTM Credit Spread trader to face a catastrophic loss on their very first trade, and once this happens, there is no way to recover since a winning trade will only bring back 10% on the remaining capital.
Alternative Trades to Credit Spreads
San Jose Options does not teach Credit Spreads. We use them combined with other spreads and for adjustments, but we never place a credit spread alone. This is one of the riskiest trades that you can do with options. Our options course is focused on Safety, and we have strategies that help us to protect our capital and keep us away from high risk strategies such as this one.
