Finding the Optimal Credit Spreads - Oct 8th, 2020

okay good afternoon and welcome back everyone to our options education webinar series my name is tony zhang i'm the chief strategist here at options play and today we're here to talk about a very popular trading strategy one that we use very often in our daily plays which is selling vertical credit spreads so we'll talk a little bit about the strategy just so for those of you that are relatively new to credit spreads a better understanding as to how they work when they should when you should utilize them how do you select the optimal credit spreads but most importantly we want to show you how you can find optimal credit spreads using the tools that we have built here at options play and then make sure that you understand how to analyze them and how to manage these if you are trading credit spreads in your account so let's go ahead and get started now before i do what we're going to discuss here today is purely for education and demonstration purposes it is not a solicitation or recommendation to buy or sell any specific securities so for those of you that are brand new to options play if you haven't signed up yet you can sign up for a free 30-day trial at optionsplay.com so that you can access the tools that we're going to show you here today both the options play platform as well as the credit spread opportunity report that is updated every single hour to give you a better sense for how to find opportunities here in the market now uh what we have here for today is the we're going to be doing maximizing credit spreads um maximizing income with credit spreads this thursday next thursday because earnings season is about to kick off again we're going to start talking about earnings season using options and then the final thursday uh of the of of september of october we're going to be doing a live market analysis with q a um i am taking the last thursday off here this week uh for for the month of october so that's what we have for the month of october a lot of i would say action actionable strategies that we're going to teach you here this month so make sure that you pay attention to and then we're going to do a review here at the end of october now we do have a very special election special coming out tomorrow morning for those of you that join us on each tuesday and friday morning market outlook session we are we're not doing a regular market outlook session tomorrow morning we're going to be doing an election special we're going to talk about um what the what the possible outcomes are for the election how we're viewing the different industries and sectors that will be affected by the different possible outcomes by taxes by regulation and we'll break down each individual sector and what we're currently looking for this is a members only webinar so you need to either be on a free trial or you need to have a membership to to register for that so i hope to see many of you there tomorrow morning for that at 9 00 a.m so today what we're going to do is we're going to talk a little bit about when should you sell trade credit spreads it's very important that investors understand when you should utilize credit spreads they're not useful for all market conditions they're only useful for certain market conditions so it's important that you understand when then we'll take a look a look at what credit spreads are how they're constructed and more importantly what are the optimal credit spreads how do you actually determine whether a credit spread is optimal or not then we'll take a look at how to manage your credit spread so once you're in a credit spread how do you actually go about deciding when to get out of a credit spread and then we'll try to do as many live examples as possible using the opportunity reports that we're going to show you here that's available to you for everyone here at options play and at the very end we'll open this up for q a so the primary objective that i want to help investors walk away from today's webinar which is really understanding how can you find and trade the most optimal credit spreads and when i refer to optimal i'll show you here in a few minutes as to what we mean by optimal and how can you quickly find them so that you're not searching manually through symbols and options chains to figure out what symbols to sell credit spreads on how to find expiration dates and strike prices our opportunity reports automate all of that work for you so we want to show you how to access them and more importantly how to use them analyze them and trade them so my name is tony zhang i'm the chief strategist here at options play and what i'm going to do here today is show you the tools that we have developed here at options play that's designed to help you find these strategies as quickly as possible analyze them so that you know what are optimal ones what you're seeking when you're cert when you're selling a credit spread for you to go ahead and execute those in your portfolio so let's talk first talk a little bit about when should you sell credit spreads now the thing about credit spreads is that they're only useful in certain market conditions first of all many investors especially for those of you that are experienced i tend to get a lot of answers from experienced options traders that will tell me that it's best to sell credit spreads in a higher volatility environment and that is absolutely true that generally speaking in a higher volatility environment credit spreads will do better but it's important to understand that just because you have a high volatility environment does not mean that other strategies are not suitable many times you can still use other strategies even in a high volatility environment so what i want to be more clear on is respect to the directional view because even though you have relatively larger exposure to implied volatility when volatility is high so when you're selling credit spreads in a high volatility environment you're going to get a little bit more profits you're going to get a little bit more profit from the fact that volatility is likely going to mean revert and give you a little bit of boost here to your profits however even with credit spreads your biggest exposure is not to vega which is implied volatility your biggest exposure is still to delta so the directional view that you have on an underlying stock is still going to be the most important aspect to determine when it's optimal to sell a credit spread and when you should actually sell that credit spread from a directional perspective so when we look at credit spreads we generally want to do them around reversal points so whenever we think that markets are going to reverse from one direction to the other these are your optimal conditions to sell a credit spread you want to do them during market reversal so this could be many different ways to do that you can use support or resistance that's the simplest way to look at a chart and see where you think a market may start to reverse either higher or lower for other technical analysts that use different type of momentum indicators whether you use rsi or macd or stochastics any time when when an oscillator is either overbought or oversold are also conditions for potentially um selling a credit spread because again overbought and oversold conditions tell you that momentum is shifting and it's turning around and reversing in the opposite direction and lastly when you have a trading range when you've established a trading range and you think that the markets are going to stick stay within a specific range that also is generally speaking a good opportunity to sell credit spreads so the first thing to remember with credit spreads is the fact that your biggest exposure is still to delta not vega so don't use implied volatility as your sole decision making process as to whether you want to trade a debit or a credit spread we're going to explore a little bit about the difference between debit versus credit spreads after we explain credit spreads but the first thing to remember is the fact that directional view is still the most important thing when you're selling credit spreads that makes sense everyone please type one into the chat window if that makes sense to you delta is still always going to be your largest exposure even when you're selling credit spreads so don't just use implied volatility as your sole decision-making process as to whether you want to trade a debit or credit spread make sure that you have a good sense for the directional view and use these types of technical indicators to determine when prices are about to reverse because that is going to be your optimal time to sell a credit spread so for this what i'm going to do is i'm going to walk you through two types of credit spreads because there's a bullish credit spread and a bearish credit spread we're going to talk about the bullish credit spread first this is when we have a bullish to neutral view and i'm using ibb here this is an older chart here of ibb when it's clearly in a strong uptrend and i would have particularly looked for was small reversals during this uptrend that signified a potential reversal because every time it declined a little bit towards that 20-day moving average that became the subsequent reversal higher so this is an opportunity to potentially see that ibb and a clear uptrend pull back for a few days to the 20-day moving average here's my opportunity to look for a reversal in that trend to resume that longer term bullish trend so this is an opportunity where you could potentially sell a credit spread so in this particular case ibb was trading at just around 142 or so so the optimal credit spread is to generally sell a put near the current price of the stock because that maximizes the income that you collect because at the money options will always have the most amount of extrinsic value and you're maximizing that by selling the out of the m the at the money put option however when you sell an at the money put option you are taking on number one a substantial amount of risk if the stock is to substantially reverse lower and number two when you sell a at the money put option you're going to have to put up a lot of cash or margin in order to sell that underlying to sell that short put so most investors don't feel comfortable enough to sell that naked call or cash secured put i'm sorry naked put or cash secured put because maybe they're concerned that there is maybe a small but inherent possibility that that p um uh that the ibb or this etf declined significantly i would say the number one question that i get from investors saying when we talk about selling cash secured puts on stocks that we want to own is what do i do if the stock declines substantially the answer is there's not much you can do the same thing there's not much you can do when you buy a stock and the stock declines substantially that's the risk that you're taking when you buy the stock that's a risk that you're taking when you sell a put option but not every investor wants to take on that risk so that's why we turn to credit spreads credit spreads allow us to take a very similar trade to selling a cash secured put or naked put at the money which maximizes our income but we do it in a way with limited risk so what we do is we buy a lower put against it in this particular case let's say i buy 136 put against it and let's say i collect five dollars and 10 cents by selling the 142 put i paid 2.95 to buy that 136 put now what happens is instead of risking roughly uh 142 or so or rather 137 or so to make five dollars here what i'm doing now is by buying that lower put i reduce my potential reward right i've reduced it from five dollars and ten cents down to my net credit whoops uh my my five dollars and ten cents down to two dollars and twenty five cents but what i've done is i've decreased my risk so if i just sold the naked put for about five dollars then my total risk on that trade is about 137 granted that's far-fetched because the stock would have to go to zero in order for that to happen by my expiration date but what i have done is i've reduced my risk from 137 down to just 3.75 so this allows you to potentially sleep at night and know for the know that no matter what happens even if the world turns around while you sleep you're not taking on substantial amounts of risk you're not putting on a huge amount of risk in your portfolio and you can normally to sell a single put you would have to put up roughly 137 000 in cash to sell i'm sorry thirteen thousand dollars in cash to sell this naked put that substantial amount of money versus to sell the credit spread you only need three hundred and seventy five dollars so that's really in my opinion the real reason why many investors would rather sell the credit spread rather than sell the naked put because naked put simply requires too much in terms of cash to be set aside to make that five dollars versus if you can set aside just 375 and make potentially 225 that makes a little bit more sense okay does that make sense everyone please type two into the chat window if that makes sense to you i'm not sure uh oh someone said that i did my math wrong here if this is 2 2 15 um and that the risk is actually 3 3 85 okay i apologize for that a bit of math error on my end so uh let's see 510 minus 95 that's correct um so a little bit a little bit less credit than we were looking for 10 cents less credit but the thing that we want to think about whenever we're talking about a credit score or any type of vertical spread is really the distance between the two strike prices the distance between the two strike prices tells us how much money is at play whatever the distance is that's the maximum amount that we're in play on any type of vertical spread so a 142 136 is a six dollar wide credit spread the distance between the two strikes so whenever we talk about the width of a vertical we're talking about the distance between the two strikes and what we generally want to take a take a look at is how much credit are we receiving as a percentage of that width because whatever your width is the collection that you have in terms of income the rest of it will be your risk so whatever you collect an income the rest of it will be your risk so whenever you're able to maximize your income what you're doing is you're reducing the amount of risk the more you you take in an income the less risk that you're actually taking so this was calculated off of the 225 which we know is off by 10 cents but 225 out of a six dollar wide credit spread means that i'm collecting 37 and a half percent of the vertical width that means the rest that i'm risking is going to be uh my my potential risk so here i'm risking 37 and 37 and a half percent of the vertical width or my potential reward is 37.5 of a vertical width and my risk here is 62 of the vertical width so what i'm trying to do is always to find credit spreads that maximize the amount of income because that for every dollar that i or every cent that i increase my income by i decrease my risk by that one penny so the goal here is to always make sure that you try to trade strategies that give you the highest amount of income the highest amount of income also gives you the largest buffer so in the past month in september we look we learned about buying versus selling options and we learned about a few different scenarios that when you're buying options you need the stock to make a big move in order for you to be profitable when you're selling options you have a lot of different ways to make money if the trade goes in your favor you make money if the stock stays put you make money even if the stock goes a little bit against you you also make money and only if the stock makes a big move against you do you lose money so when you're selling a credit spread you have the same risk profile meaning if ibb starts to move higher i'll make money on this trade if ibb moves sideways and doesn't move higher at all i make money here if the ibv goes a little bit lower i still make money the only time i lose money is if ibb takes a big plunge to the downside as long as ibb stays above 139.75 which we know is actually 139.85 because of the 10 cent error that i had as long as ibb stays above 139.75 i'll be profitable on this trade so that is what attracts many investors to selling credit spreads it's a high probability it's a very forgiving strategy if you get the direction right you make money if you get the direction wrong you can still make a little bit of money only if you get the direction completely wrong do you really lose substantial amounts of capital and that's what many investors are seeking when they're trading these types of credit spreads does that make sense everyone please type three into the chat window if that makes sense to you okay so let's just take a look at a bearish example here now let's just say you have a contrarian view on ibb you believe that ibb is near a top you think it's going to start reversing lower for whatever reason and you think that it's now going to start perhaps reversing a little bit lower so as an options trader what you can do is naturally as a first step you might want to sell a 142 call option so in this particular case if i sold this 142 call option for about four dollars and 80 cents this gives me a little bit of a buffer meaning as long as the stock stays where it is or moves even a little bit higher i'm able to be profitable and as if the stock does move lower i'm going to collect my 4.80 but the problem with selling a naked call is that you truly have unlimited risk if ibb continues to move higher the more the higher it goes the more money you lose and the only thing you have to show for that risk is just four dollars and 80 cents not a whole lot of potential reward for what could potentially be a lot of risk and this is why many investors who don't like to sell naked calls or puts not to mention selling that naked call is going to require a fair amount of margin in order to do so so what you can do is you can buy back a higher call let's say you buy the 148 call and spend 2025 cents to buy it now instead of bringing in a net credit of four dollars and 80 cents now you're bringing a net credit of just 2.55 but in order to do that what you've done is you reduce your risk on the entire trade down to just three dollars and 45 cents now in this example just like before we're trading a vertical spread that is a 142 148 which as we said before the distance between the two strikes is the maximum amount of capital that's at play so that's 600 per contract so when you have a vertical width of six dollars and you're collecting two dollars and 55 cents before in the previous example in that bullish example two dollars and fifteen cents was about thirty six percent of the vertical width here we're collecting two dollars and fifty five cents we're really getting a little bit more income for it and what that equates to is now a vertical width of 42 before we're collecting 36 37 percent now we're collecting 42 and this is really where it starts to get interesting because when you're able to collect 42 that means instead of you're only risking uh six uh 58 of the vertical with in order to um to take on this type of reward so now your risk reward like before was closer to two to one this one is much closer to one to one so you're looking at 42 to 58 before you were looking at about 37 to about 60 um 63 or so so this is really where the max when you're able to maximize your income what you're able to do is reduce your risk and this is really the goal of what we're trying to seek when we refer to optimal credit spreads we're really trying to seek credit spreads that give you the maximum amount of income possible for so that we can minimize your risk so that all things are equal you're able to be profitable more often because you have a bigger buffer because now that now that you have a three a 2055 credit your buffer is also expanded from about two dollars and fifteen cents in the previous example now to two dollars and fifty five cents so even if ibb moves higher you now have a larger buffer before you lose money on this trade than before because you've you've increased your income by that extra 30 40 cents on this particular trade so if ibb stays sideways you make money if ibb moves lower you make money and if ibv moves a little bit higher you'll still make money the only time you lose money is if ibv makes a big move to the upside does that make sense please type 4 into the chat window if that makes sense to you and i know there's a few questions and i will get back to you on some of these questions but i do want to get through this content and then i will come back for questions here at the very end so just to recap the credit spreads they are what we call a very forgiving directional strategy because you could really get the direction wrong and still potentially make a little bit of money but it's really suitable for when you expect more of a neutral or small directional move the reason that it's not suitable for when you expect a big move is that there are far better strategies for it that's what we learned last month in our buying versus selling options webinar i highly recommend if you missed that to please go back and watch that because what we learned from that from what we learned from that webinar was the fact that when you do expect a big move you're much better off buying a call or buying a put or buying a debit spread which is something that we will talk about here in the next month or so buying debit spreads are very useful when you expect a big move in a specific directional view now credit spreads do generally work better in a higher implied volatility environment now how do you measure a stock with high implied volatility that's really where we turn to iv rank we're going to show you how we measure iv rank on our credit spread opportunity report so that you know which ones have higher ib rank but generally speaking any iv rank above 30 is considered relatively high and anything above 50 is considered extremely high so if you see an iv rank above 50 that has a much higher probability of giving you better returns than iv ranks below 30. now from a directional perspective like i said even though it is a strategy that gives you better returns in a high implied volatility environment you still need to get the direction right so you generally want to look for extreme overbought or oversold conditions using technical indicators you want to look for reversal points whether you're looking at top and bottom formations using chart formations or if you're looking at support or resistance levels these are all suitable ways to determine a potential reversal point at which you may want to sell a credit spread and lastly you do not want to use this strategy when you're expecting a large and fast move so you only want to use this when you expect more of a small and neutral move in the broader markets or in the specific name or etf that you're currently trading so with that what i want to do is help investors better understand the trade-off that you're making when you're selling credit spreads because many times investors will say well i will obviously choose the strategy with a higher probability i will obviously choose a strategy that makes me money in three different scenarios rather than just requiring the stock to make a big move but what's important to understand is that you are making a trade-off when you select these higher probability trades that make money in a lot of different scenarios and it really comes down to the fact that whenever you're choosing any option strategy doesn't matter if you're trying to select different strike prices different strategies you're always making a trade-off between two important factors and that's risk reward and probability so a lot of investors if we talk about just buying call options you can buy at the money call options that are relatively expensive or you can buy these really far out of the money call options that are really cheap and unfortunately i see too many beginners will say well i'm going to buy the cheap one because why would anyone buy to buy the expensive one not really realizing what trade-off you're making when you're buying these really cheap out of the money options and it really comes down to the trade-off between probability and risk to reward a lot of investors tend to get attracted to the cheap really high risk reward strategies meaning if you buy these really far out of the money call options which fueled some of the rallies that we saw in late august these out of the money call options that made a boatload of money in a very short amount of time and guess what that stopped working immediately right after it did work for about a month or two and it really comes down to the fact that that's the trade-off that you're making when you seek these really high payoffs those really high risk reward ratios you have very low probability in the long run of making money and that's the same thing that you have when you're selling credit spreads credit spreads have higher probability of profit but it's important to remember that you have worse substantially worse risk reward ratios most credit spreads you're risking usually at least double of the potential reward that you can make but you do have more winners so you win more often but the times that you lose you will lose more than what you win each time that you win subsequently when you buy options when you're using debit spreads what you have are really low probability of profits a lot of investors will say well something has 33 percent probability of profit i'm not interested in that because they're thinking to themselves well if i lose two out of three trades i'm never going to make money but what they don't realize is the trade-off with that with the trade-off of low probability is that you have better risk reward for most debit spreads you're risking 100 to try to make 200 so your reward your risk reward are at polar opposites if you will and probability and what you're trying to do is find a balance or within each strategy what you're trying to do is you're trying to maximize or give yourself an edge so what we're trying to do is move this from instead of 200 worth of risk for every 100 reward what we're trying to do is something along the lines of how do we reduce your risk here to about 180 and increase your reward here to about 120 or so something along these lines because whenever i'm able to increase my reward what that does is it decreases my risk and we do the same thing when we're trading debit spreads we try to reduce our risk as much as possible because what that does is it increases our potential reward so one strategy is not better than the other i keep hearing from investors saying i prefer to sell credits for credit spreads because they're better or i prefer to do this because they're better the reality is that none of these are better than the other they're all similar because you're just making trade-offs between probability and risk reward is low probability worse than high probability no is high probability better than than low probability no not at all you just have to understand what you're trading off for that probability and that i think is one of the most important lessons to learn when you're trading options because everyone's seeking this kind of holy grail or magic bullet that somehow makes them more money the reality is that that doesn't exist but once you understand these concepts you can make better decisions that can put the edge in your favor and that's what we're going to show you here today so if that makes sense to you please type 5 into the chat window perfect so now that we've talked giving you a few examples let's talk a little bit about what are the optimal credit spreads so from our perspective and this is something that you know for those of you that join uh the the sessions with tom sosnoff at tastyworks you know we've we've talked about this a lot and we have slightly differing views as to what our optimal credit spreads but we all agree that the different choices that you have with respect to credit spreads generally speaking the difference in terms of performance between each one is generally relatively low um so what we feel are the are the optimal credits where it's based on our back testing is really designed to minimize risk as much as possible our goal whenever we optimize for credit spreads is to minimize risk because when we minimize risk we're able to maximize our potential returns even if that means that you have a slightly lower probability of profit but the part that tom and i generally agree on is that you generally want to sell about 45 days out from expiration you want to start out about 45 days out where we disagree a little bit as far as which legs you buy and which legs you sell we sell the 50 delta and we buy back the 25 delta which makes your net delta about 25 delta so your net delta here is about 25 delta now what tom likes to do is he likes to sell the 35 and then he buys the 25 i'm sorry the 20 so that his net delta here is only about 15. now what his strategy does is that generally speaking his strategy will have higher probability of profits but lower income our strategies will have slightly lower probability of profit but higher income now this is really where you as an investor could make decisions on your own we're going to show you how you can use the options play tool to do that but we are also going to show you the tools that will first point you in the right direction and then you can make the choice for yourself as to what strategy is best suited for you but we we both agree that generally speaking you want to try to collect at least one third of the distance between the two strikes so if you have a five dollar wide credit spread you want to collect about a dollar sixty seven ten dollars three dollars and thirty three cents uh twelve twenty dollars six dollars and sixty seven cents so generally speaking these are probably the most common credit spreads that you'll sell so we generally have kind of these uh burned into our head whenever we're selling credit spreads is that regardless of what width you're looking for you generally have a range as to what you're trying to seek now when you're using these types of strategies you'll usually see that you'll have about 67 winners or 67 probability of profit while risking about 200 for every 100 in potential income that you receive so that is what we generally consider the optimal credit spread now i consider this optimal because i never want to risk more than two times what my potential income uh is and when we sell the 50 to 25 delta what we generally tend to find is that we can actually get many times closer to 40 percent of the width rather than one-third so when we have 40 income what that means is that our risk is reduced to 60 of the vertical width so instead of risking two to one we're only risking about one to one and a half or so which significantly reduces our risk and that's what we're trying to seek in our strategy reports that i'll show you here in one second but before we move on to showing you our our opportunity report i do want to talk a little bit about once you've entered a credit spread how do you go about managing it and generally speaking this is the part where tom and i are in complete agreement on which is really that there are three possible triggers to exit your credit score and whichever one triggers first that is your signal to get out of the credit spread whether it's at a at a profit or a loss you want to get out whichever one of these threes triggers first so number one if you get to 21 days to expiration that's the first trigger the second trigger is if you made 50 percent of the max gain and the third trigger is you've lost 100 of the max game so just to give you an example if i sell a five dollar wide credit spread and let's say i collect two dollars in income for that five dollar wide credit spread what i want to do is if i reach a one dollar profit on that particular trade i would take profit if i reached a two dollar loss i would take my stop loss or if i reached 21 days to expiration first without reaching either take profit or stop loss i would also get out of the trade regardless of whether i'm in a profit or a loss if i'm at 21 days and i haven't reached my take profit or if i haven't reached my stop loss i would simply get out of the trade so i just want to make sure everyone understands the math here so i sold it originally for two dollars so if the trade starts to go in my favor then the income that starts to decline so half of the max gain so my max gain here is two dollars half of that is one dollar so if it goes from two dollars down to one dollar then i've gained one dollar on the trade so then i would take my profits and move on to the next trade if this trade starts to go against me and the value of the credit spread starts to rise instead of declining and it rises up to four dollars that's when i would consider cutting my losses and taking a loss on that particular trade and if let's say it reaches 21 days to expiration and we are not at either one of these profit levels either take profit or stop loss then i would get out of the trade all together now some people will ask about rolling whether it makes sense to roll from my perspective if a trade is going against me it doesn't make sense for me to roll simply because the directional view that i had on the trade is incorrect and i'm not going to continue rolling and putting more money at risk for a trade that just didn't work out but if the trade starts to go in my favor maybe it hasn't reached my take profit yet but it did reach 21 days to expiration that is an opportunity to roll your position out another month and maybe adjust the strike prices a little and stay in that trade so for example if ibb continues to grind its way higher but it doesn't move much higher but at 21 days to expiration maybe i've made 20 or 30 of the max game then at that point i make ask myself do i think ibb is going to continue moving higher if i do then i may roll that trade into from a november maybe out to december but that's really the time where i would want to roll my position when the trade goes against me that's not when i want to roll my position because i simply got the direction wrong i don't want to throw more money at a trade that didn't go correctly you can place another trade if you feel strongly about it but generally speaking that's not what i do but that's a choice that you have to make i'm just letting you know what i generally do when it comes to deciding whether it makes sense to roll does that make sense everyone please type six into the chat window if that makes sense to you and i know there's a lot of questions here i will try to make sure that i get to your questions a lot of questions about the 21 day rule the 21 day rule really comes down to the fact that many investors have this view that time decay is fastest in that last two to three weeks but what they don't realize is that when you have very fast time decay there's an additional risk that you're taking on which is gamma risk and gamma risk starts to outweigh the acceleration and time decay in those final two to three weeks which is why whatever we're selling options selling credit spreads selling cover calls selling naked puts selling iron condors we generally want to avoid holding those trades in the last two weeks because in those last two weeks yes you're getting a little bit extra income per day but you're taking on a whole lot more of gamma risk and what we're trying to do is avoid that gamma risk that's why we close it out 21 days from expiration if we want to roll it out another two months out to the december or january or however long it you're going out you can do that if you want more time on your trade but always roll it out don't hold it in the last two to three weeks into expiration because you're taking on a lot more gamma risk so with that what i want to show you is the credit spread opportunity report that is available to all options play members you can find the credit spread opportunity report at the bottom of your options play platform when you click on the credit spread report or credit spread link and what it'll take you to is an opportunity report and i'll show you very quickly as to how the opportunity report works but what the opportunity report is designed to do is that there are 4 200 symbols that you can trade options on but we know that the vast majority of those 4 200 is not very liquid so first of all we filter out all of those non-liquid symbols so we're only looking at what we consider very liquid optional symbols this usually is about 100 to 200 names per day and then what we're looking for are credit spreads that collect the minimum of that 33 percent that we're referring to because if we collect less than 33 percent that means we're risking more than two to one so we never want to sell credit spreads we're risking more than two to one so by filtering out 95 of the names through liquidity and then we take a look at all the spreads all the credit spreads that don't that don't collect at least 33 of the width meaning the wrist rewards are not in our favor and then lastly what we do is we align it with our technical view so what we have is a directional edge on the view of the of the trade like i said the most important one of the most important things of selling a credit spread is still the directional view so what we have is a report that gives you out of the thousands of possible combinations and thousands is it's really more like millions of possible combinations it filters it down to usually in the realm of 10 to 20 possible credit spreads and this report is actually updated for you every single hour and to understand how to read this report you can read it from left to right first of all you have symbol and direction that is pretty straightforward what symbol is it is it a bullish or bearish trade then we'll tell you the credit spread details meaning what strike price are you buying what strike price are you selling what expiration date are we using and then one of the most important things is risk for reward this is what we're talking about how much are you collecting of the vertical with as a collection of the income the higher on the list you go the better the risk reward the lower you go on the list the worse the risk reward so what you always want to do is focus on the ones at the top of the list first because those are the credit spreads that give you the maximum amount of income for the amount of risk that you're taking so this apa trade that i'm talking about here collects one dollar out of a two and a half dollar wide credit spread that's forty percent of the width that means i'm making potentially forty percent of the width and i'm risking only sixty percent of the risk this is when the risk reward is skewed in my favor and then we have a few different things that helps you better uh sort and filter these if you'd like which is iv rank we talked about iv rank when high is generally speaking a better opportunity for selling credit spreads and also the next earnings date so that you know whether or not there's an earnings coming up generally speaking we don't love selling credit spreads going into an earnings event so we generally want to understand if there are earnings coming up now with earnings season coming up right now it's a little harder to avoid so maybe sometimes you could sell a 45 day option on something that doesn't report earnings for another 20 or 30 days that's fine because you're you're likely going to exit the trade before that earnings date but it's important that you know what the iv rank and the earnings dates are and like i said this report is updated hourly so the very last column tells you when the report was last updated we update this every single hour starting at about 10 15 a.m after the market opens we update that every single hour all the way through the close and the last snapshot is around 4 15 4 16 or so after the close so we generally use this report intraday we generally don't use it after hours and the reason only because of that is because after hours we tend to see that the spreads get wider so sometimes we get some funky um premiums that are not really executable so that's why generally speaking we use this report only during the intraday so this is a report that you all have access to and it really allows you to quickly scan for possible opportunities and i'll show you this real quick using the current credit spreads report so this is what was generated just about an hour ago before we started this um this uh this webinar so the two that kind of jumps out at me are the two uh tesla and um and an slv now tesla reports earnings in 13 days so that may not be the best suitable one because but it does have a relatively high iv rank so for those of you that perhaps are looking for an earnings play this is also one way that you can play earnings with limited risk but the one that i wanted to take a look at was silver silver collects in this particular case 39 percent of the width it's got an iv rank of 40 which is pretty high here and silver is currently trading at 22.20 this would sell the 22 strike by back to 20s that's a two dollar wide credit spread that i'm collecting 77 cents on that's 39 of the width so what i would do is i would take this trade i would bring it up in options play and i would look at this using options play so slv you know and i was looking at gold here earlier today or silver certainly broke down below that support level but recently finding a little bit of support maybe it's ready to bounce back higher here so this depends on whether you agree from a directional perspective but silver looks a bit oversold those are the conditions that we generally look for for a bullish credit spread and what we're looking for is to sell the 22 and buy back the 20 point credit spread as you can see the midpoint here is still 77 cents so i'm still able to execute this trade at the price from about a couple of hours ago and this allows me to utilize the options play tool to see what happens and how much premium do i potentially collect if slv starts to move higher between now and expiration so if it moves up to let's say 23 how much can i potentially make by let's say halloween so using the p l simulator allows me to better understand what my potential outcome for these credit spreads are but this prevent this means that i don't have to search for specific symbols i don't have to see if there's liquid or not i don't have to specifically pick expiration dates and strike prices the report does all of that work for you and provides you all the information that you need to decide very quickly which one of these you want to pay attention to plug it into options play and immediately be able to analyze them and potentially trade them or execute them into your broker's platform so i'll just take a look at a few of them here just to show you how quickly i can take a look at this let's say i don't mind tesla's earnings coming up in 13 days and i see that tesla's trading at 429 or so this is telling me to sell the 420 356 put credit spread here on tesla so let's take a look at that 420 356. so tesla's certainly been range round here for the past couple of weeks or so it's been trading itself into a bit of a triangle here maybe you think that there's going to be a breakout here to the upside so what we can use is we can use our strategy constructor to construct a short put vertical we're going to sell the 420 by the 356 or so so that is a 50 60 dollar wide credit spread that i'm collecting 26.60 for 26.60 on a 64 wide credit spread is a little over 41 of the width here so this is one what i mean tesla does have very high implied volatility you know as we saw here before the iv rank here is 39 so that's why i'm able to collect a little bit more premium here collecting that much premium allows me to again minimize my risk and you can use this this tool to help you understand what's your maximum reward what's your maximum risk and quickly be able to calculate that using the options play tool so this is really designed from the ground up to make your credit spread trading experience as quick as possible because i know that as a trader the amount of time it takes you to number one research an underlying stock pull up the option chain determine which expiration date strike price liquidity iv rank earnings date all that stuff takes a lot of time to collate that data and many times you do all that work and then you realize that the credit spread doesn't collect enough premium or there's an earnings coming up or the iv rank's not high enough there's there's a lot of wasted time in that we wanted to avoid all of that through this credit spread report and this is designed from the ground up to facilitate us as traders to quickly find these opportunities we many times use this to find our daily play ideas we we pull from these reports to look at these stocks to see opportunities and these are the ones that we present on the daily play ideas so this is a very powerful tool for those of you that are looking to sell credit spreads to find ideas but also be able to understand how they're constructed so i hope that this webinar was helpful in giving you a better understanding of credit spreads themselves and more importantly the tools that we have here at options play to help you find and hopefully execute and analyze these types of trades so with that that covers what i wanted to share with you here today i hope that this was again helpful for those of you that are relatively new to credit spread so learn more about it and for those of you that are currently selling credit spreads i hope that these tools will help you quickly find opportunities in the market rather than taking so much time to find those so with that what i'll do is i'll open this up for q a i have a few minutes available for q a i don't have a lot of time however there's a chat window and there's a q a window what i like please is if you have questions to please type them into the q a window and i will answer your questions through that q a windows section and i will do it as quickly as possible but i do have to run here in a few minutes but i do want to try to answer as many questions as possible michael's asking what do the colors indicate indicate so the colors are really color coded so that i think from a premium width perspective it's fairly um self-explanatory the green ones means that you have the most amount of income for the amount of risk from an iv rank perspective what you're looking for are red iv ranks because the higher the iv rank the redder they are if you will um the lower the iv rank the greener they are so it's just it's just color coding so it's easier to spot which ones have a higher iv rank so facebook as you can see out of all of these actually have the highest ib rank here out of all of them but credit but this particular one only collects 34 of the width so the premium here is not as attractive as something as this but certainly still up there in terms of an opportunity that is suitable in my opinion uh define iv rank iv rank is just taking the let's say this was the implied volatility chart of a stock over the past year all we're doing is taking the absolute low right so let's say if this was 10 and we're taking the absolute high let's say this was 100 then what we're going to say is where is today's value in respect to this range so like like we said the range was from 100 to 210 so if today is down here then what we're going to say is iv rank is maybe 10 meaning it's at the bottom of its one year range that's what ivy rank is trying to tell you but if let's say iv was up here it would tell you the iv rank is 90 meaning it's very high compared to the range that it's been over the last year so that's how iv rank is calculated it's pretty simple when i log into options play i cannot find it bill you can't find the credit spread report it's at the very bottom of your screen on the black bar the very bottom called credit spreads is there a separate subscription to the credit spread screen or as a part of the package it's part of your options play membership is iv is iv as high day prior to earnings what is the best play um if iv is high day prior to earnings what is the best play so david you know like i said iv is not your sole decision making process as far as what's the best play the best play is dependent on your directional view because your biggest exposure is to delta so if you think the stock's going to make a big move perhaps you might want to look at buying some calls or puts or spreads um if you think the stock's not going to make a big move then you definitely want to sell credit spreads like this but it depends on where you think the stock's going to go lawrence is saying have you ever dealt with an early assignment there's a risk that you need to be concerned with that's a great question lawrence um yes early assignment is not particularly um the most fun thing to go through but keep in mind that when you get assigned early on a credit spread it doesn't change the risk of the trade your maximum risk remains the same even if you get assigned early unless you let the short leg roll expire and you still keep the stock leg that's when your exposure changes but as long as you hold the trade to expiration your risk does not change so generally speaking if you get assigned early on a credit spread the best thing to do is to simply close out both legs the stock leg and the remaining long put our call that you have left and get out of the trade altogether it's not a high risk but if you do if it does happen you generally just want to exit the trade can you please explain gamma risk um so gamma risk is really the risk that you take being short the option so delta delta goes from zero to one that's your delta range and at expiration as you get closer to closer expiration the stock becomes very sensitive it can either go all the way to zero or all the white way to one very very quickly even with a very small change in the underlying stock price so gamma tells you how fast the delta is changing so as you get closer to expiration the at the money options have the highest amount of delta risk meaning you can go from a big winner to a big loser in a very short amount of time based on just the stock price moving a very small amount so it's a sensitivity to p l from the stock price moving up or down and gamma gets really high as you get as you get closer to expiration and that acceleration and gamma risk is not worth it in the last two weeks before expiration why does the credit spreads not score over 100 it really comes down to the risk to reward ratio from the fact that you do still have a fair amount of potential risk here now tesla is a volatile stock so even though we're selling a buying back to 356 notice that the trading range for tesla is all the way down to 2 307 so there's a still high amount of probability that tesla will actually move down substantially so that's why the options place score is not particularly high because you still have a fair amount of risk that tesla blows through your lower strike and continues moving lower between now and the november expiration but again we're not really trading until november expiration to be perfectly honest you know we're really trading closer to october 30th as you can see that's closer to 338 as the expected trading range so you can use that to kind of adjust your expectations for your your outlook for the underlying stock what about drm i'm not sure what drm refers to chuck if you can clarify please explain buying versus selling delta so if you're long an option you're a long delta if you're short an option you're short delta um rather rather sorry i take that back a long call is long delta a short call is short delta a long put is short delta oh a short put is a long delta it really depends on it's just your exposure to the underlying stock delta is just telling you whether if you make money if the stock goes higher or lower so that's all delta is telling you is the sensitivity of your option to the underlying stock price moving higher or lower what's your favorite technical indicator when deciding to sell a credit spread i tend to use either cci commodity channel index or an rsi those are probably my two favorite indicators i am doing a special members only webinar next friday so this friday we have an election special next friday i'm doing a technical analysis one i'm going to be talking about indicators we've back tested thousands of indicators over uh 13 years and we have the performance reports of all these technical indicators i'll be sharing that with you in our members only webinar next friday i hope those of you that are interested in technical analysis will be able to join me for that jacob's saying should credit spreads be bought at market or limit prices if limit what limit you should always use a limit price and we always encourage you to try to start with the mid price and move your way up i'll move your way down sorry um and we actually have a webinar just on this alone entering option orders on our youtube page i highly recommend you to watch that jacob if you have not watched it james can we get these slides yes all the slides are available to you in the youtube description every single time we upload something to youtube the slides are linked in the description so please if you're watching any of our webinars on youtube and you want the slides look in the description you'll be able to download the slides is there a subscription to access options play spreadsheet um so the full options play membership gives you access to all of these things the earnings calendar the liquidity report the credit spread report that is all included in your membership for for options play there's no additional subscription for that would still like to know about p l data i'm not sure what you mean by clifford what you mean by p l data if you don't mind clarifying i'm happy to answer that question where can you find the spreadsheet it is at the bottom of your screen here where it says credit spreads that's how you can find the spreadsheet could you i think i've just talked about that could you explain what you mean by gamma risk i think i've also discussed that as well what is the math of the 3700 in 13 17 original credit spread oh jacques i was saying that if you sold a naked put not a credit spread i was saying that if you sold the naked put here if you sold this 142 put you would subtract five dollars from 142 that gives you roughly 137 multiplied that by 100 shares that's how you get a margin requirement of about thirteen thousand dollars to sell a naked to sell a one forty two put a cash secured put on on that ibb that's what i was referring to are they updated on the hour every day they're updated about on the 15 uh on every hour so 10 15 11 15 12 15 and so on all the way through 4 15. what is an easy way to tell my profits that is at 50 so edward that depends on your brokerage firm um each brokerage firm has different ways to show you your p l most brokerage firms do just can display your p l from a percentage perspective that would be the best way what's the risk reward for condors deltas so we usually sell about a 35 delta on an iron condor and buy back about a 20 delta on an iron condor so those are the deltas that um tom refers to in his uh credit spreads tom ted is saying received today to close crm call spread but did not change in the web um so ted we will update that after to close here today philip saying hey tony so when when we sell a credit spread is not considered a naked call no it is not a naked call because it is covered it's effectively covered by the long call that you've purchased our michael donovan another great educational session options play is a great tool for someone trading options any option strategy works well for me thank you so much i really appreciate those kind words brad suggestion consider inverting the color coding for iv ranks so that you're looking for green across the board for the best ideas okay brad i can take a look at that i mean we usually want to use high iv with red we usually associate that color red with high iv and green with low iv but i i'll take a look at that bill is saying i don't have the black bar bill send me an email at info optionsplay.com and i'll take a look at your account as to why you don't see that um what is a 50 delta call or put so why i do recommend that you take a look at some of our basic educational webinars but delta is basically an approximation of the probability of a strike price being in the money at expiration so 50 delta caller put is generally speaking what we we refer to as the at the money strikes so we usually sell the first strike outside of the at the money strike prices on these credit spreads are you working also with the debit spread list yes we are also working with the debit spread list and that is something we will be publishing here in the next um in november has there been a comparison of probabilities before expiration versus after exploration to see how close probably is actually um patrick yeah so deltas we've back tested this for many many years all the way back to about 2007 before the financial crisis it is it is resound it is it is crazy how accurate delta is to actual probabilities of expiring worth of sparring in the money at expiration so yes a lot of people have been put to i ca i can't explain to you the countless computing cycles that options traders have put onto this task of calculating their probability models and whether they are accurate or not because that is effectively the intellectual property of all market makers and options traders is how good their volatility models are and how accurate they are at predicting probabilities recommended expiry is the same for all trades do you recommend expiry dates to be out if we are trying multiple trades from the list um no so we always use 45 days to expiration that is your optimal expiration date for selling a credit spread um we just we sometimes may vary by week so sometimes some symbols we might sell the weekly option other ones we might sell the monthly options but generally you're not deviating more than no more than about seven days or so when would you consider different expiration dates in the two options of the credit or debits not sure what you mean by that barry but uh you know the credit spreads we usually sell about 45 days out debit spreads we'd like to go a little closer to 60 days we're actually making some of our modifications to our application to account for that where debit spreads are naturally selecting strike prices a little bit further away than credit spreads so there's a lot of things that are coming up in the options flight platform to switch between debit versus credit spreads and automatically showing credit spreads in the options point platform um and yes there are plans to include the ability to create your own portfolio rather pull in your portfolio from your brokerage firms and also some paper trading possibilities a lot of questions about paper trading so we're exploring the ability to paper trade using options play can one see these slides yes all of them are available on our youtube channel if you look at any video on youtube there's a link at the bottom in the description with the link to the slides if you want to download them can you repeat what tom does and what you do with the delta so i sell the 50 and buy back to 20 tom sells the 35 and buys back the 20. so his delta ranges are a little smaller his net exposure is only 15 delta so he has less delta exposure than ours so his usually has less income with a high with more risk but it comes with a higher probability of profit so many of his probability of profits are closer to 80 percent winners but they're many times risking about two and a half to one on the trade rather than a two to one is the max risk really just the spread of the strikes minus the premium collected is the max risk yes that is the max risk is just the difference between the shoe strikes minus the premium that you collected can you ever lose more than this amount um no you cannot lose more than this account unless you get early assigned and you don't manage them correctly and unless you hold them to expiration get a signed on one leg and then let's say the market moves over the weekend and you have a substantially large exposure where the long where the long leg is no longer providing that protection but again if you keep to the rules by closing out your trades at those rules that we're referring to here then you will never lose more than the max loss of that trade let's see do you have a gamma scalping strategy bill uh we do not have a gamma scalping strategy do you calculate iv rank i.e 39 for tesla versus implied volatility and tesla think or some shows 80 so iv rank is different than implied volatility if you go to if you go to think or swim and you scroll to the bottom of your options chain there is a tab there is a section on your options chain called option statistics under those option statistics there's a indicator here called iv percentile you'll see that iv rank for tesla will probably be very close to 39 as well iv rank only goes from 0 to 100 it's a different indicator than implied volatility that's a completely different thing implied val iv rank is calculated from implied volatility but implied volatility and iv rank are two different things i thought iv rank varied depending on which option you choose iv rank different than i've that's correct iv rank and iv are completely different iv rank is a generalized volatility indicator versus iv is calculated for each individual strike price that you can trade please recommend a book for technical analysis joseph i've i've been so far out of technical analysis in terms of books um i'd have to look that up you can send me an email at info optionsplay.com and i'll take a look but i i honestly it's been probably a good 10 years before i've read a technical analysis book i tend to find that chart school on stockcharts.com is a really great online resource because technical analysis is much more interactive these days you need a computer to do that technical analysis so i find reading a book then going on to your computer is a little bit more difficult if you go to chart school at stockcharts.com it's fully interactive and you can chart immediately on that platform so i do recommend that what time is the friday webinar the friday webinar the election special that we're doing tomorrow is at 9 00 a.m you have to be a member in order to sign up but it is at 9 00 a.m is there a spread bit ask that you would not enter because it's too wide so ted what we've done with these credit spread reports is we only look at very liquid names so i don't have to worry about how wide bid-ask spreads liquidity open interest volume i don't have to worry about any of that these are all names that have already passed bid ask spread filters i'm sorry liquidity filters isn't picking five to ten percent out of the money short strike instead of at the money a safer play it forgives you even if you have the direction wrong a little bit so this is a great question the question was why not just choose something really far out of the money and this is what i see a lot of beginners do they'll sell something really far out of the money and they do it because they think that okay i have a lot more room to even if i'm wrong i can i can still make money even if tesla goes down to 3.85 yes that is true but what you're doing is you're taking on a lot more risk for the amount of reward that you're doing like i said all things are trade-offs right what you're trading off now is a higher probability of profit for a substantially worse risk reward if that's what you want to do by all means just understand that when you do lose you're going to lose substantially more i want to make sure that no matter what happens even if the trade completely blows out and the stock goes really far in the opposite direction that i'm expecting to that i do not take on a substantial amount of risk when you do these high probability trades that you're talking about you absolutely can do that there's nothing wrong with it just understand what you're trading off when you're doing that and unfortunately most of the people that lost most of their money during this sell-off were doing those types of strategies so when when qq was trading at 300 we were seeing a lot of people selling these one week 290 280 even 270 options that just got blown out from one quick move to the downside and from my perspective this was a sharp move but it was nothing compared to what we saw during the coronavirus right you know if you had sold some of these strategies i saw some some credit spreads where people were collecting a few hundred dollars in income and taking on about 4 500 worth of risk because they were selling these really far out of the money credit spreads and they thought to themselves well i have 98 probability of profit 99 probability profit i'm good i'm gonna make money 99 of the time forgetting the fact that the one percent of the time that they lose money they wipe out potentially months if not years worth of gains from that one bad month and all you need is one bad month one big black swans and it takes you out completely that's why i don't like doing that because in my cr in my trades even if you have a month where the stock market is down 40 the most i'm losing is roughly one and a half to two times the income that i'm collecting that's the reason why i choose to have these relatively lower probability but much lower risk rates so don't just don't just pick trades because you have a higher probability of profit that is the one mistake that i see most beginners make is that they choose probability of profit over everything else to their detriment in the long run it works for you in the short run it's better for you in the short run but in the long run it blows up in your face we call this is what traders call picking up pennies in front of a freight train um because that's literally what you're doing you think that you're winning all the time you're picking up small profits every single week week to week and you're thinking to yourself this is a great way to make income and all it takes is one bad week and you've wiped out months if not years worth of gains um do you have strangle videos on youtube so i currently don't have a strangles video we don't sell a lot of strangles here but i certainly can create one there's something that has been brought up a couple of times here over the past month so i will consider adding that here in november profit loss so i'm not sure you know joseph what you mean by profit or loss if you don't mind clarifying i understand profit or loss i just don't know what your question what profit loss is is it better to use strike prices on five dollar increments is these tend to be more liquid so michael um yes and no so i really like the weeklies because they provide a lot of flexibility in being able to um to pick strike prices that i specifically want i can get much more granular i can find that 50 delta i can find that 25 delta when they're five dollar strikes you tend to find it's a little harder to find exactly the strike you're looking for um however you know liquidity is a factor of the stock not which expiration date you're using so it's not like the monthly options are more liquid than the weekly options that's a common misconception a lot of users will see is that weekly options have low open interest and volume that's because they were just listed a few weeks ago maybe just a few days ago that's why there's low open interest in volume but there's not they're not any less liquid you can trade them just as easily as you can the monthly option so don't be afraid to trade those weekly options that have no open issues or volume put your orders in at the mid price you'll see that you'll likely get filled especially in the names that are in the varied liquid names on our list sorry to ask again is there a p l on the spreadsheet trades that you've taken using the spreadsheet is their profit clifford so yeah we've you know in our daily play um performance uh spreadsheet all the p ls are on there all the closing trades you can see what when we entered when we exited what the profit and loss is on each trade why are why is there no credit spread report on the canadian version michael that's something that we're working on but um you know the canadian version is different it's a free version the us is a paid version that's why we spend a lot more efforts here in my opinion on the u.s version but we are continuing to expand on the canadian we're looking to build iv rank for canadian we're we're working on new reports including that credit spread report that is something that we are working on here for the canadian markets do you offer free trials yes you can sign up for a free trial at optionsplay.com we have a free 30-day trial you can go to optionsplay.com to sign up for i'll post a link into the chat window just posted that into the chat window okay i have two minutes for a couple more questions please paste the youtube links so you can find our youtube channel at optionyoutube.com optionsplay i'll post that link into the chat window as well is it possible to enter your own stock into credits for a data spreadsheet um no but there's really no need to because you know that's what the options play tool is for um you can enter into options play and look at it there once in a trade how do you how do you use your portfolio function so that's something that we don't have access to everyone just yet that's only available to us to enter those trades into that but we are currently looking at building out that portfolio tool for you guys to be able to enter your own trades does 21 days to expiration apply to cover calls generally speaking carlos yes it does as well i have to slide the window up above my taskbar to see the black black bottom oh okay um bill you might have to oh okay see look at that's a response to someone else is it possible to include the cover calls and short put reports on the options play website um martin that is something that we are in the process of doing so we are we have embedded the cover calling and cash secure put reports into a website we hope to we're actually hoping to release that website maybe in the next week or two so very very soon you'll be able to see that within the website okay i think i i'm unfortunately running out of time here i have to run but i really tried to get through as many questions as possible i know many of you still have questions to the options play tools so please you can always submit questions to us using this question ask us thing here at the upper right hand corner for any questions you have regarding your trading strategies and we'll answer your questions typically within a couple of hours with that thank you so much for taking the time out here this afternoon i really hope that this was helpful in giving you a better understanding of how to utilize credit spreads for your portfolio and how to find those optimal credit spreads where the risk reward is skewed in your favor so with that thank you so much have a great evening and we'll send out the recording with the slides to you in about an hour or two once we finish processing the recordings have a great night and i'll see you guys tomorrow morning bright and early for our election special for our members have a great night

Channel: OptionsPlay

Views: 25,701

Rating: 4.8831615 out of 5

Keywords: options education, options trading, credit vertical spreads, vertical spreads, implied volatility, delta, calls, puts, IV rank

Id: bk9Co7V6AI4

Length: 72min 48sec (4368 seconds)

Published: Thu Oct 08 2020