Credit spreads have a high mathematical likelihood of achieving profitability; however…
So why don’t I consider them one of my favorite types of trades? Because they also have a high risk of loss, and that means stress. Credit spreads are highly directional and that by itself implants the kind of risk into the trade that you have to watch like a hawk.
Still, many option traders like credit spreads and will continue to use them regardless of my warnings. So here I present a very simple adjustment strategy you can apply to credit spreads to lock in your profits when they do happen to work out as planned. This will help reduce the riskiness of these trades.
As an example, imagine you enter into a credit spread and the market goes in the right direction quickly. Right away your trade is up 5%. You might be tempted to exit this trade at this point, to capture the profit. This seems reasonable. There’s a simple adjustment, however, that you can use to lock in your profits and then continue to stay in the trade even longer.
All you need to do is add a debit spread to the existing trade in order to neutralize the Delta and lock in profits on your credit spread. This will give you the chance to make money should the underlying asset suddenly move sharply in the opposite direction.
Since the market nowadays moves up and down and up and down again so frequently, this simple adjustment strategy can work quite well. This is one of my favorite adjustment strategies for capturing profit on credit spreads for two reasons. One, it’s very simple and straightforward and two, you can make even more profit when the market unexpectedly reverses.
As an example of how easy this adjustment can be to make, let’s say you’re trading the RUT and your credit spread is a bull put spread at strikes 700 and 730. Well, as soon as you realize a profit, just buy a 760 and sell additional 730 contracts. This can end up looking just like an unbalanced butterfly where the number of debit spreads does not equal the number of credit spreads.
If you expand on this technique, you may well develop some very effective adjustment strategies because this type of adjustment gives you a chance to lock in existing profits and safely stay in the trade. Nevertheless, credit spreads are not my favorite types of trades as I’ve already mentioned. I hope those of you who do enjoy trading them can appreciate the value in locking in those early profits.
Please let me know if you find this simple adjustment strategy useful.