If you’re new to trading Options, then chances are that you’d be starting with a small trading account.
What’s considered a small account?
That would be any trading account size under $10,000.
So if you have a small account and you’re just starting out, how do you grow your account fast?
The answer: The hands-down fastest way to grow a small account is by using Credit Spreads.
That’s because Credit Spreads are one of the safest Option trading strategies, and they can be highly profitable when traded the right way.
What Exactly Are Credit Spreads?
Credits Spreads (aka Short Vertical Spreads) are premium-selling Option strategies that let you take a semi-directional bet in the market.
It’s also considered safe because it’s a defined risk strategy where your maximum risk is capped.
Unlike a Naked Put or Naked Call, even if the stock crashes or rallies past your Credit Spread strikes, you can only lose the amount you have risked with this strategy.
So if the maximum risk that you’ve defined at the start is $350, then you can’t lose more than that amount.
Whereas with a naked put or naked call, then you can potentially lose much more than the capital requirement for putting up the trade.
Two Types of Credit Spreads
There are two types of Credit Spreads.
If you’re bullish, then you’d want to use the Bull Put Spread (aka Short Put Spread).
The Bull Put Spread consists of:
- An out-of-the-money (OTM) Short Put
- A further OTM Long Put
If you’re bearish, then you’d want to use the Bear Call Spread (aka Short Call Spread).
The Bear Call Spread consists of:
- An OTM Short Call
- A further OTM Long Call
In both the Bull Put Spread and Bear Call Spread, your loss is capped by the long option.
So the maximum loss is the width of the spread (the distance between the short strike and the long strike), minus the credit you received for the spread.
For example, let’s say you sold the 100/105 Bull Put Spread for $1.50.
This means the width of your spread is $5, and the maximum risk on this spread would be $5 minus $1.50, which equals $3.50.
That means the maximum risk would be $350, and the premium you’d receive for this trade is $150.
That’s because each option contract controls 100 shares.
So we always multiply the credit (or debit) by 100 to derive the dollar amount for the trade.
Why Are Credit Spreads The Fastest Way To Grow A Small Account?
Reason #1: High Probability Trade
When you structure your Credit Spread the right way, you can have a high win rate.
For example, if you use the 30 deltas for your short strike, you’d have approximately a 70% win rate.
That means you will see more wins than losses which can help your trading psychology.
And that’s because a high probability strategy has a shorter losing streak compared to a low probability strategy.
If you choose a low-probability strategy and the losing streaks come, you might start doubting your strategy and even start doubting yourself.
So while a low-probability strategy may still be profitable in the long run, you may end up giving up on the strategy halfway because of the long losing streaks.
The advantage of trading options is that you can design your own win rate.
So why not choose a trading strategy that has a high probability of success rather than a low one!
Reason #2: Positive Time Decay
Because Credit Spreads are premium-selling strategies, you have positive theta.
And that means that you generally have time decay working for you over time.
And what time decay does is gradually erode the value of the Credit Spread.
Remember, with Credit Spreads, we get a credit upfront.
And for us to make a profit, we have to close the trade for less than what we sold it for.
For example, if you sold a Credit Spread for $1.50, you want to buy it back for less than that.
So let’s say you manage to buy the Credit Spread back for $0.50.
That would mean a profit of $1.00, which equates to $100 per Credit Spread.
So time decay helps you erode the value of the Credit Spread as time passes so you can close the trade out for lesser than what you sold it for.
Reason #3: Quick Profits
Credit Spreads are considered semi-directional trades.
That means that it can profit in three ways:
- The market doesn’t move much from when you put the trade on.
- The market moves slightly against you.
- The market moves in the right direction for your trade.
Of all the three ways, the fastest way to profit is when the market moves in the right direction of your trade.
For example, if you put on a Bull Put Spread, then you will make the quickest profits if the market goes up.
Similarly, if you put on a Bear Call Spread, then you will make the quickest profits if the market goes down.
That means, if you are right in your direction from the time you put on your trade, you can quickly close your trade in just a few days and get at least 50% of the maximum profit.
Doesn’t get any better than that!
Reason #4: Credit Spreads Are Forgiving
This is probably the most important reason why Credit Spreads are very popular with new traders.
And that’s because Credit Spreads are very forgiving in the sense that you can be wrong on the direction of the trade and still be profitable.
Let’s say, for example, the current price of a stock is $100.
And you sold a Bull Put Spread with the strike price of 90/85 with the expectation that the stock will go up, and if it doesn’t it at least won’t go lower than $90.
So even if you’re wrong on your bullish expectations, as long as the stock doesn’t go below $90 at expiration, you will still be profitable on the trade.
That’s why Credit Spreads can be very profitable if traded the right way.
Reason #5: Maximum Risk Is Defined
One of the biggest risks for new traders when they get started in the world of options, is blowing up their accounts.
Whenever you hear stories of option trades gone wrong and accounts blowing up, that’s usually because of naked strategies like the Short Put, Strangles, Put Ratio Spread, and so on.
That is not to say that these naked strategies aren’t profitable.
In fact, it’s the opposite.
Naked strategies are very profitable and I use them a lot.
However, when you use such naked strategies, you need to have really strict discipline in managing your trades, and you need to be very good at risk management and capital allocation.
The problem with most new traders is that they either ignore risk management, or they don’t have the discipline to manage their losses when they’re supposed to.
But this problem can be eliminated with Credit Spreads.
That’s because your risk would already be defined by the long option.
So you can’t lose more than what you’ve defined your maximum loss to be for the Credit Spread, even if the market crashes to zero or shoots up to the moon.
How To Trade The Bull Put Spread (aka Short Put Spread)
So here is a guideline on how to trade the Bull Put Spread:
- Wait for the Stochastic Oscillator to be oversold.
- Sell on a down day.
- Short strike around 20 – 30 delta.
- Place the short strike below a support level.
- Allocate no more than 5% of your capital to a trade.
- Trade management:
- Method 1: Take profit at 50%.
- Method 2: Hold till expiration.
- Method 3: Close trade at 21 DTE regardless of a win or loss.
Trade Example On IWM
In the chart above, you can see that the Stochastic Oscillator shows that the market is oversold.
The market had also been trading down.
This is where I entered into a Bull Put Spread with the strike price of 175/170.
As you can see, shortly after placing the trade the market went up and I was able to take 50% profit in just 11 days.
Had the trade been held any longer, the market would have breached the short strike.
However, that doesn’t necessarily mean the trade will end up as a loss.
The market could go back up again by expiration and the trade would still be profitable.
How To Trade The Bear Call Spread (aka Short Call Spread)
So here is a guideline on how to trade the Bear Call Spread:
- Wait for the Stochastic Oscillator to be overbought.
- Sell on an up day.
- Short strike around 20 – 30 delta.
- Place the short strike above a resistance level.
- Allocate no more than 5% of your capital to a trade.
- Trade management:
- Method 1: Take profit at 50%.
- Method 2: Hold till expiration.
- Method 3: Close trade at 21 DTE regardless of a win or loss.
Trade Example On CRM
In the chart above, you can see that the Stochastic Oscillator is overbought.
And there’s a previous high at around $165 which serves as a resistance level.
This is where I entered into a Bear Call Spread with the strike price of 175/180, which is above the resistance level.
As you can see, the stock started to trade sideways for a few days before plummeting.
And that’s when I close the trade for a 50% profit in just 9 days.
Credit Spread Takeaways
The Credit Spread comes in two forms:
- Bull Put Spread – A neutral to bullish option strategy
- Bear Call Spread – A neutral to bearish option strategy
Credit Spreads are excellent option strategies for small accounts because the risk is defined.
So there is no way a single trade can blow your account if you have the proper capital allocation on each trade.
And the proper capital allocation should be anywhere from 1% – 5% of your trading account size.
It is also a high-probability trading strategy so you can get more consistent wins.
This also helps with your trading psychology so you’re able to be profitable in the long run.
Credit Spreads are very forgiving.
You can take quick profits if the market moves in the right direction.
But you can also still profit even if the market moves against you, as long as it doesn’t stay below your short strike by expiration.
Furthermore, you have time decay working for you as well.
Overall, the Credit Spread is an excellent options strategy for you if you have a small account and you’re just getting started in trading options.
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