Liz: Hi everybody. Welcome back to the LIZ & JNY Show. I'm Liz this is Jenny, and this is our know your options segment. Kind of on the heels of our last week’s discussion about debit spreads, we're going to take a look at credit spreads. We're going to take a look specifically at put credit spreads.
Jenny: Put credit spreads today. You might hear them called vertical spreads, bull spreads …
Liz: Selling a put spread.
Jenny: Right. Selling a put spread, selling a credit spread, a bull spread because it's a bullish trade if you're selling a put spread it means you want underlying to be above your put spread expiration.
Liz: Right. All of those things, verticals, they are all called different things. They are all the same trade. As far as, if somebody was going to compare and contrast last week to this week, they are all verticals, but selling a put spread or selling an option spread is different than the debit spread vertical or wrapped around the …. all because of strike selection. Remember, when we're selling something, when we're selling a spread, our strike selection is going to be completely different than if we're buying a debit spread.
Jenny: Right. If you are looking at something and it's the same strikes. Say you're doing the 100, 105 credit spread, vertical spread, whatever. If you buy that 100, 105 call spread or you sell that 100, 105 put spread it's the exact same trade. That's why it's important, what Liz brought up about strike selection. We understand that buying a call spread or selling a put spread is the same trade if you're using the same strikes, but when we talk about selling credit spreads, we're always using out of the money, two out of the money strikes versus when we talk about buying a debit spread we're always wrapping it around where the underlying price is in the middle of the strike.
Liz: That is just a given. Going forward, I think that's … I don't that's just us. I think that's pretty typical of the tastylive kind of universe, is they're all verticals no matter how you slice it's a vertical spread. Our debit spreads are always wrapped around the ….always. No ifs, ands, or butts.
Jenny: Debit spreads.
Liz: Debit spreads are, and our credit spreads are always both strikes out of the money as far as we can go and still collect enough.
Jenny: When you do a debit spread and we wrap it around the money, that's what we talk about it's very similar to a stack position. You have a 50/50 chance. Just like if you buy yourself stack you have a 50/50 chance it's going up or down. Those you can make as narrow or as wide. Credit spreads also. You could make them as narrow or as wide as you'd like. There are strategies for everyone, for every size account. If you have a tasty bite account you can do a very narrow credit spread.
Liz: Meaning a dollar wide and risk only 70 cents. Things like that.
Jenny: Yeah, or if you have a very large account, but you don't like the idea of naked options just make a wider credit spread.
Liz: We have starting points as well with credit spreads. Selling a put spread. We like to collect … We like to keep our risk or probability of success around 70% so that means …
Jenny: It's funny I haven't heard you say that in so long.
Liz: I know. It means we want to collect around a third of the width of the strikes. If we're looking at a true credit spread, a true defined risk credit spread, I'm looking to collect about a third of the width of the strikes.
Jenny: Let's go to the ToS platform.
Liz: That has been a year since I've said that exact word.
Jenny: I know it's crazy. Again, this is not … For examples we're using SPY just for teaching purposes. These are not trade recommendations but you can carry what you learn over to any product.
Liz: Right, exactly. SPY is a liquid product with dollar wide strikes and we're going to be using that. It's kind of our go to for learning purposes.
Jenny: Okay. Let's go to the toss platform. We have SPY. Let's say I said to myself…
Liz: Self?
Jenny: Self. SPY is down today, and the volatility has come up a little bit. I would like to put on a bullish trade, but I don't want to have an undefined risk trade. What can I do?
Liz: Well, self. You can open up these … We're going to stick with the monthly options with 38 days left because this is for teaching purposes only.
Jenny: For the newer viewers the monthly options are … We do that to kind of remove the clutter. Remove the clutter of all of these red weekly's and quarterly's and just look at the white line here. We've got the January monthly's with 38 days to go.
Liz: With 38 days to go. We had said setting up the premise of the trade is it's down today we're going to make a bullish trade in this. I want to make a trade in this, not risk too much, and not have too much capital in my account to do it. I'm going to look for a simple dollar wide put spread. So the most I want to risk is the dollar. One hundred dollars.
Jenny: Simple dollar wide put spread. You're selling a one dollar wide spread that spread can never be worth more than a dollar. Whatever you collect, the dollar minus what you collect is your risk in the trade. Let's say we collect 35 cents. The one dollar minus the 35 cents gives us 65 cents then your risk on the trade is 65 dollars.
Liz: Jenny and I can flip flop between cents and dollars very quickly because we know that one option contract controls one hundred shares of stock. When we talk about a dollar that's actually one hundred dollars.
Jenny: If you see this option here, the two hundred. That's 241. It's not really $2.41 it's $241. Always options are in multiples of one hundred.
Liz: It's very simple. I just wanted to put that out there because we do flip flop back and forth between this is a dollar, and then I collected 65 cents.
Jenny: Easy way to find something. We want to sell a dollar wide credit spread, and we want to collect about 35 cents. I'm not going to do the math, I'm just going to set the spread to vertical and see what comes up and if you're trading on Dow, you can set your perimeters of what you're looking for. Click on sell put vertical and a trade will pop up for you.
Liz: There's semi specific reasons for having this as a base line. We do typically like to collect more, but starting at 30 cents on a dollar wide, that gives me a 70% probability of success. I know I have a 70% chance of making one penny on a defined risk vertical because this is a highly liquid product. The pricing of the options is telling me such.
Jenny: The pricing of the options is telling you it's a liquid product.
Liz: No … or that that is my probability of success.
Jenny: Right, because this is such a liquid product and the markets are so tight, the pricing of these options gives us our probabilities. If we went right here to this 201, 202 and sold this spread for 30 cents, to get the probability on the trade if you're trading something that's a liquid product, you take your risk divided by the spread width. Our risk on this is one dollar minus 30, so 70 cents, so our risk of 70 cents divided by the spread width of a dollar. That's our probability, 70% probability.
Liz: We have a 70% probability of keeping one penny. Now, this is just a very simple. This is a starting point. We want to make sure the rank is high, and this is how to make a directional play in something where I have a 70% chance of keeping this money. Here is what I think is the most interesting thing about, and we used to do these all the time. We evolved as traders over the years, but here. You're risking 70 dollars to make 30 dollars, right? This brings your break even down decently low in something that you're only risking 70 dollars. If the worst possible case scenario happens, and we're bullish on this, but SPY gaps down a hundred points, I'm exaggerating, a hundred points before this expires. The most we can lose on this trade is 70 dollars.
Jenny: Is 70 dollars, so the most you can lose is 70 dollars, but the most you could make is what you collect, so 30 dollars. Your breakeven is 201.70 so right now with SPY down almost 2 dollars it's trading almost 205. As long as it's above 201.70 at expiration, this trade would be a winner.
Liz: This trade would be a winner. This is just a very simple one dollar wide credit spread. You could widen it out, you could narrow it. You can play with this however you want to play with it. We do like to factor in you do have to take into effect commissions or resort fees or things like that as they like to call them in the other room.
Jenny: We never want to collect less than 30 cents on a dollar wide spread because of commissions. We want to be aware of that and managing winners when you're collecting a very small amount and you've got commissions getting in and out of trades. It's very hard to close a trade and manage a winner.
Liz: With this kind of a spread, I believe this is a great stepping stone to start in to see how things happen. To see how things move without really risking too much. If you noticed from that confirm and send page, we don't have to go back to it, but 70 dollars is what you need to have on in your account. These types of things are wonderful for tasty bites accounts or to kind of see how volatility works, and how option pricing works.
Jenny: And just to learn options. Right. Here you're risking 70 dollars to make an options trade, and worst case scenario this trade is a loser and you lose 70 dollars, but hey you've learned something about options. Again, this type of trade is a trade for a beginner, it's a trade for learning, and you evolve from this. Do you do these trades anymore?
Liz: No.
Jenny: I don't either. It's a starting point to learn, to grow, and to move onto the next level.
Liz: I shouldn't say that because sometimes if Nick will put on little things, sometimes I'll put them on with Nick. A lot of times I'll have these on in conjunction with a Nick had put, but that's a story for another day. We can layer them. When you start with something like this, this won't cause people anxiety to look and watch how this plays out.
Jenny: If you are starting and learning, I would do one of these. I wouldn't do ten of these, I wouldn't do five of these. I would never do more than one of these because if I was willing to do more than one of these I would come up with a different strategy.
Liz: You would widen the strategy out, which you can do as well. The differences are, this is a bullish strategy, so we're creating a bullish strategy where we have a 70% chance of success versus if 50/50. Here we have a 70% chance because this product can go all the way down to 201. What is it 201.70?
Jenny: Yes, 201.70.
Liz: This product can go all the way down to 201.70 at expiration before we start losing money.
Jenny: Before we start losing money. This is a put credit spread, it's a bullish trade. You sell. I'm going to walk through this without it being set to vertical so people see what you're actually doing. When you sell a put vertical whatever strike you choose, you're selling the more expensive put. So here in this case we were selling the 202. That was 285. We were selling this 202, and we were buying the 201 so we are selling the more expensive and buying the less expensive. You can see the prices here. If you're selling one and collecting 285, and you're buying one and paying about 255, that's where that 30 cents comes in. That's the credit you are receiving.
Liz: If you look at this, I hope I'm not going to say this backwards because sometimes I do this when I'm looking at these. When you look at this if you're selling this 202 put, you're bullish at 202. You're going to be buying the stock at 202. What you're doing is your bearish at 201. You're buying the stock at 202, and selling it at 201. Which doesn't make much sense, because--
Jenny: That's where the dollar and risk comes in.
Liz: That's where the dollar and risk comes in, so that's what you’re doing. That's the most that you can do. They're protecting. This 201 is protecting this. You can never lose more than that because if it drops down beneath it, you have the right to sell it. You're buying it here at 202, and you have the right to sell it at 201 which is your protection. Your risk definition.
Jenny: Again, we use the pricing of those options to give us the probability. You can see here the probability of those options, and it's close. It's close enough using the pricing for the probability. We get a lot of emails saying I hear about selling options Wednesday under deviation way. I want to sell put spreads. I want to sell put spreads one standard deviation way. If you're going to that standard deviation, you have to make the spread very wide in order to collect anything.
Liz: When you layer the components together, everybody wants it all. I want it all too, but you can't. You can't collect enough to be that far away. What we try to do, and this is what I kind of said in the beginning of the segment too. We want to collect a third of the width of the strikes by getting ourselves as far away as we can and collecting that much. Sure, you can go really far away and collect 10 cents, 15 cents, 5 cents.
Jenny: Right, because here at one standard deviation that's what it would be. One standard deviation is the option that has an 84% probability of expiring out of the money. That's the 191. If you sell that 191, and that's your more expensive put and you buy that 190 that spread is 8 cents. Do some people do this? Yes. You have to sit and let this expire.
Liz: You have to let it expire. We are out of time for this segment. I don't know. Did you want to finish your sentence?
Jenny: No. Those types of trades people do, you just have to let them expire. There's never managing a winner with something like that.
Liz: We like to collect around a third of the width of the strikes. We're going to take a quick break. When we come back we've got trade small trade often, but we are opening the phone lines right now so give us a call.