The Right Strikes

 

Date: 4/6/2021
Author: Chris Hood

 


Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.


 

If you’ve been trading options any time at all, chances are you’ve heard of a bull put credit spread (BPS).

This powerful strategy is one of the first trades I teach beginners. 

It’s simple, powerful, and versatile!

Just like the boxer’s straight right or jiu-jitsu fighters cross collar choke, it should be a staple of your trading plan.

Just as a refresher, we’re selling one put IN THE MONEY and buying another further IN THE MONEY for the same expiration.

Your profit potential and risk are defined the moment you place the trade. You can only make or lose the difference in price between the two options.

Let’s use RIOT as an example.

The bitcoin-related stock MARA really had a great day on Monday, so let’s assume you believe RIOT might follow suit or at least hang out in it’s current range.

As of market close on the 5th of April, it sits at $56.90. You might consider the following trade.

Sell 16 Apr 21 50.00 Put @ 1.85

Buy 16 Apr 21 46.50 Put @ 1.03

Your profit potential on this trade is the difference (or the spread) between the two strikes; 0.82 or $82.00 per contract.

You’re risking $268.00, but the spread has a 68.38% of winning.

As long as RIOT doesn’t take a dive below your short strike of 50.00 by April 16th, you’ll keep the premium.

Every day the price holds above your short, time decay erodes the value of the spread. 

At expiration, you’ll keep the full $268.00!

And if you’re like many traders, you be satisfied to close the trade early at 60-80% max profit to increase your odds of winning.

BTW I’m not suggesting this RIOT trade. It’s just for illustration.

But who knows, it might work.

One of the most common beginner questions is, “Which strikes do I pick for these spreads?”

It comes down to two key questions.

How bullish are you on the stock?

What balance of risk versus reward do you find acceptable?

I can’t answer these questions for you because there are no one-size-fits-all answers in trading. However, I can give you a little insight into MY rules.

Strikes with deltas of 0.25 (short) and 0.15 (long) deltas are excellent high-probability trades when markets are flat, range-bound, or rising slowly.

On the right stock at the appropriate time, they have about a 70% success rate.

I’ll rely on theta (time decay) to bleed the value from these spreads and make me money. If the stock goes up, I’ll just profit sooner.

The example on RIOT I used earlier is one based on this idea.

On the other hand, I’ve come to appreciate the 1:1 risk to reward of setting my short strike AT THE MONEY

If my technicals are all flashing green and the chart looks bullish, I prefer this method.

In fact, I placed one such trade today on AMZN. It looked ready to run, and the calls were just a bit overpriced.

The BPS let me participate in this upside momentum WITHOUT overpaying.

Sell AMZN 23 Apr 21 3200 Put

Buy AMZN 23 Apr 21 3195 Put 

The spread is 2.26, or 226.00 per contract, with my max loss very close to my max gain. 

I don’t know if it will work out, but something tells me it will.

Ultimately, you need to decide for yourself when to use these types of spreads. I use both but have come to prefer the 1:1 version.

The key is to find a level of probability and risk that brings in profits over the long term!

Give my ideas a try and adjust them to fit your needs. This goes for every trading decision you make.

You must build a plan that fits you. 

No one else can do this for you, and it takes work to figure it out.

Pick your rules and stick with them. Evaluate your results and make adjustments.

This isn’t a suggestion my friend, it’s a prescription!

Now get after it!

Next time we’ll cover a topic that will keep you from having to stare at your monitor or phone all day, the autoclose order.

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