Put Credit Spreads ~ Sig Style

When it comes to trading in options, the “go-to” trade for me has always been a put credit spread. With the options skew and the way options pricing works, I can typically roll a trading that is losing and get the new position under the market after it quits falling. Let me walk you through some of the concepts I use to trade these put verticals. I like to focus on companies with strong fundamentals (increasing sales numbers, increasing institutional investment, increasing earnings) and on charts that do not have massive repeated gaps or large parabolic moves. I also want to avoid things that have earnings due within my trade time.

Days to Expiration DTE

I typically avoid starting a new position with less than 21 DTE yet I do not want to go farther out that 65 DTE. This leaves room for decisions to be made about the length of the trade – decisions which rest more on the options we see in these options series. A “monthly” options series typically has more liquidity but also typically has wider strikes and a wider bid / ask.

Notice in the picture above the 12 Feb series has the word weeklys but the 19 Feb series does not. That is because the 19 Feb series is a monthly series; the strikes in that monthly series are $5.00 wide while the 12 Feb series has $2.50 wide strikes. I would want to start the trade small and I would also want to start in a place that has a lot of liquidity (or open interest). There is more open interest in the monthly series – but I can build the trade smaller using a weekly series.

This is not something that I would resolve for you ~ this is actually something you have to determine for your-self. Either of these series would be ok; if the trade needs to be fixed or rolled later, we would not lose simply because we built the trade $2.50 wide or because we built it $5.00 wide~ but a smaller account may not want to roll into a new (and potentially bigger) position if the trade begins to fail, so starting the trade small gives us the opportunity to expand our position later.

Days to Expiration DTE

Another thing to consider when it comes to determining DTE is the account size. A smaller account is typically going to focus on quick growth – closing positions frequently and opening new positions. If the account is small enough that new trades can not be taken until existing trades are closed – the DTE becomes something of a road block. I still like the +21 DTE for starting a new position, but if I have a smaller account and need to chose a higher or lower DTE due to liquidity or strike selection, I will typically chose the next closer series over the series father out.

An account with more funds may not be concerned with the buying power reduction – and this gives larger accounts more flexibility in their DTE choices – but, return on capital (or the ROC) does not get bigger just because the trade is built with more DTE. If the max profit is $100 – there is not going to be more than 100$ generated – no matter how far out the DTE.

To say it another way, a $100 profit credit spread can be built 2-hours from expiration, 2-days from expiration, 2-weeks from expiration, 2-months from expiration, or even 2-years from expiration but – it will not generate more than $100 profit. Since a large account does not need to free up capital to open a new position it may be beneficial to go with the timeframe that settles into the higher end of the 21-65 DTE.

Strike Selection

I like to build my put verticals with at the money (ATM) strikes – often called a Greek Neutral trade strategy or an In / Out spread. If we build a trade ATM – we want to collect “near” half the width of the spread. This gives us a 50% probability spread while also giving us a 1:1 risk to reward ratio where we are seeking to risk one to make one. If the trade is $1.00 wide, I want to collect “near” $0.50 in credit. If the trade is $2.50 wide then I want to collect $1.25 in credit.

I would also recommend building the trade with both strikes OTM just to see what pricing you are offered – and check multiple series for a better pricing. Due to how implied volatility flows through the options chain – building various spreads in different series may allow you to find a “sweet spot” or an edge within the pricing model.

Remember that STO or sell to open trades have their entire profit showing at the open – we can not make more profit than the credit collected when the trade is opened so work the order to sell the position for a fair price. You wont lose trades just because the position is opened with an unfair price, but you wont have the opportunity make as much profit.

Win Rate

Most places teach selling verticals using OTM options but I have never really appreciated that type of trade logic; those far OTM spreads have a historically high win rate but do not generate a lot of profit. Thankfully – each trader can determine which way suits them better.

Those far OTM options have a high probability of profit or POP. I know that may sound enticing, but if you have a very high chance of winning you should not be offered a very high profit opportunity. Why? Because trading is about taking risks.

Since a put credit spread can be rolled effectively if the market fails support – my own personal win rate with ATM spreads is 98%. Of course there is always a risk – any trade can lose. The whole of the market can fall due to an economic shut-down from a virus, from negative economic data, or from earnings. Because of these types of risk, I do not put “too much” capital in any trade. “Trade small. Trade often.”

Finding A Trade at Support

I developed this trade strategy when I was still working a day job – I would take my one-hour lunch break and find a market resting “at” or near support on a daily chart. This is easy to do – since most brokers allow you to sort a watch list by change %. I look at what has gone down today and seek to place a trade on that market with an expectation that good companies do not continue to go down.

I look for a company that has a strike width suitable for my account and with enough open interest to make me feel comfortable. The expectation is that good companies may have weakness or may pull back from a higher position – this is my opportunity to enter at the lows. I also look for the next lower support level, since we need to recognize that support can fail and we may need to roll the position down in the future.

If that next support level seems like a long distance or seems “too far” for a roll, I will avoid that market and go look for another market to enter. This is why I avoid things that have gaps or have had a recent parabolic move – the next lower support is often a greater distance than I want to roll.

Finding a Break Out Trade

If I can not find any new trades from a market near support, I will switch over to the positive change % and look for things that are breaking out on a daily chart or a weekly chart. Breakouts are more risky – but they are still a trade opportunity. Everything that was discussed above still applies – I want to make sure there is liquidity within the options chain, I want to build the position at a size I am comfortable with and I want to avoid parabolic moves or massive gaps.

Put Credit Spreads Recap

This is how I trade credit spreads on the put side – and hopefully you are beginning to realize that a lot of the pieces to this puzzle are just simple trade concepts. Options trading is no more difficult that any other style of trading – we focus on good companies at support or breaking out and then trade with a position size within our comfort level.