The Daily Market Forecast... Optimizing Credit Spreads

Thursday’s Results: Neither suggested trade triggered.

Quick Tip: Optimizing Credit Spreads

Same-day expiration SPX credit spreads are extremely popular trades for income generation. Recently the CBOE has added Tuesday and Thursday expiration contracts proving the popularity of the trade. Now you can trade a different strategy for income 5 days a week.

If you’re not familiar with the trade here’s a brief explanation: You select a price level on the chart that you believe price will NOT touch/exceed today. For the Bear Call spread that level would be way above current price. For the Bull Put spread that level would be way below current price.

The trade is entered by selling a call/put for a credit and buying a protective call/put for a debit. You will net the difference. Your maximum risk on the trade is the difference between the strikes less what you were credited on the spread.

That’s a mouthful so let’s look at the numbers. A typical net credit may be $50 or so. With the spread being $5 wide and the option representing 100 "shares" that means you’re risking $450 to make $50. That is a poor reward/risk ratio. There are many ways to mitigate this risk the primary being strike selection. You want to pick strikes that pay out enough to justify the trade but don’t get violated except in extreme conditions. 

Your skill in determining the price levels is key. The better you are at picking turning points the more credit you can get without increasing your risk of failure. Using volume at price, not in a time interval, to find the “hidden” levels of support and resistance has edge.

Another popular method is measuring the ATR extension from the prior close and current open. Price tends to stall or reverse at these levels enough to add them to your analysis. Here’s a gift for you from our research. The standard lookback for ATR is 14 periods (in this case using a daily chart). Hard evidence shows that looking at recency is better. Try a 5-day lookback for some extra edge.

These are two of the factors we look at daily in our trading room.

Today’s Best S&P Turning Points:

Sell 4292.50 stop 4297.50.  

Buy 4093.50 stop 4087.75.

Trade Fearlessly,

Mike Siewruk

P.S. Did you know there are specific tools and formulas you can use to change your personal psychology about trading to improve your results? Learn how to change your unwanted behavior here.