Options Jive

Credit & Strikes for Spreads: Why 1/3 of Width Works

| Jun 16, 2016
Up Next
    Options Jive

    Credit & Strikes for Spreads: Why 1/3 of Width Works

    Jun 16, 2016

    A Credit Spread is a strategy that combines receiving an edge from selling option premium and making a directional bet on the underlying. A spread combines both a long and a short option of the same type (ie. put or call) and in the case of a Vertical Spread the risk is spread across a range of strikes and in the case of a Calendar Spread the risk is spread across different expirations. We have some “rules” at tastylive when establishing Credit Spreads. What are these “rules” and why did we choose them?

    The first rule is actually a pair of qualifiers. We only choose out-of-the-money (OTM) strikes and high Implied Volatility (IV) and IVR environments. Since it is a Credit Spread, the short strike is closer to-the-money. We then establish the long strike at a level in which the credit received is equal to approximately ⅓ of the width of the strikes. That credit though has to be high enough for the risk. A risk graphic comparing different width vertical spreads was displayed. The graphic showed that the higher the credit gave us a lower probability of profit (POP) but a much better risk-to-reward ratio.

    The reason we have these “rules” is because no trader is perfect. The rules enable us to be profitable when we are right yet still give us room and make a profit even when we are wrong. A graphic displayed the Delta risk of two different vertical spreads with the same space between the strikes but differences in Delta. The graphic showed that the higher Delta vertical spread will see more price movement and provides the ability to manage winners. The lower Delta spread would have to see huge moves in the underlying or be held to expiration to see profits. When we collect more premium and put the risk-to-reward more in our favor, we allow for directional profits should the underlying move our way while still benefitting from Theta (time decay). Tom and Tony noted that they “prefer the ⅓ risk metrics because it helps offset the transactional costs and to build a series of mechanics that you will never forget.”

    Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the valuable takeaways and for an understanding of how and why we select our strikes when establishing vertical credit spreads.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

    More like this

    tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer.  Options, futures, and futures options are not suitable for all investors.  Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.

    tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.

    tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.

    tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.

    © copyright 2013 - 2024 tastylive, Inc. All Rights Reserved.  Applicable portions of the Terms of Use on tastylive.com apply.  Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.