Understanding Debit vs Credit Spreads l Options Trading

okay good afternoon and happy new year everyone welcome back to our options education webinar series my name is tony zhang i'm the chief strategist here at options play and we are kicking off 2021 with a options topic that i haven't covered in a while but i get a lot of questions regarding this because we do trade quite a bit of these both debit and credit spreads recently we've been selling a lot of credit spreads this year predominantly because volatilities have been very elevated this has produced the type of environment that has uh been successful with selling option strategies but we have taken a few debit spreads as well whether you traded recent ones like plug power earlier this week or electronic arts from a couple of weeks ago these are all um different types of spreads that we're currently trading in our daily place we get a lot of questions from investors asking us the difference between the two and they're actually quite different from each other they're as different as buying options as as selling options and we usually think of buying options and selling options is very different from each other and reality when you look at debit and credit spreads they are just as different so today that's we're going to break down and hopefully help you guys better understand these strategies now before we get started 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 just to give you a sense for the january calendar here um what we have is today we're going to be talking about debit and credit spreads for today but on next tuesday actually we're going to have a special session again with tom sazenov and tastyworks many of you love the sessions that i've been doing with tom sasenoff so i'm glad to be able to have him back and show you guys um another market outlook session what we're going to do is we're basically going to look at the markets together look at different trading ideas and use the trading tasty works platform to look at different ideas and talk to tom about different strategies and answering your options education questions the following thursday what we're going to do is we're going to talk about calendar and diagonal spreads and that really is you know from my perspective the next step in understanding debit spreads because debit spreads and diagonal spreads and calendar spreads are actually very similar in nature they're different strategies but they're based on the same fundamental principles so we're going to take a look at debit and credit spreads today we're going to take a look at slightly more advanced strategy calendar and diagonal spreads the week after and then on the this is actually the 21st here we're going to talk about trading earnings um trading earnings using options and i'm going to give you a little deeper dive into how we look at options around earnings how do i research the ideas around earnings a lot of questions from investors asking us you know what metrics do we look at to determine whether a stock might beat or miss on earnings so we're going to dive into some of that as well give you a little glimpse into the type of research that i do when we put out trade ideas that are on earnings such as the ones that we do on cnbc so bill you're right i miss i messed up some of the dates on there we'll correct that before we send that out so today's session we're going to start off we're going to talk a little bit about the difference between stock versus option strategies we're going to talk about bullet strategies we're going to talk about strategies but the examples today i'm going to give you are only going to be focused on bullish strategies you can take the same concepts and apply them to bearer strategies they're effectively just a mirror image of each other but today just for the sake of time so that i can actually dive into each one of these a little deeper we're going to start off our conversation talking about buying call options that is a simple strategy that most of you understand we're going to show you how you can improve uh the challenges of buying a call option using a debit spread and then what we're going to do is we're going to flip this on a dime we're going to show you selling a put option which is quite different from buying a call option and show you how you can improve that by by selling a credit spread and once we go through these four examples we'll be able to directly compare debit spreads and credit spreads to each other and then what we'll talk a little bit about is how do you select the optimal debit and credit spread and more importantly how to manage them so once you're in a debit spread once you're in a credit spread how do you manage them and then at the end we'll open this up for q a and try to go through a few examples so um the primary question that i want to help investors answer here off of the um the ses the session here today is predominantly around how can you know how are debit and credit vertical spreads different from each other and the reality again is that they are very different from each other and it's important that we understand how um how to analyze them and just a quick reminder tomorrow morning another members only session we're going to be doing electric vehicles a lot of questions from investors over the past few weeks regarding neo around the tesla regarding all of the other electric vehicle companies so we're going to do a deep dive into this whole industry deep dive into specific companies within the electric vehicle space so i hope they look forward to seeing you guys tomorrow morning if you're a member you're automatically registered for it you don't have to do anything you'll automatically get the email an hour before we start tomorrow this is at 8 30 a.m tomorrow morning so you'll get an email at around 7 30 in the morning with your uh link to log in just like the one that you did here for today um so you don't have to do anything if you're a member you're automatically registered for that event so my name is tony zang i'm the chief strategist here at options play and today what i want to do is i want to really take that deep dive into the fundamentals between buying versus selling options so that you can better understand the difference between uh debit versus credit spreads so we'll start off the conversation talking a little bit about the difference between stock versus options trading and we're going to break this down into bullish and bearish segments here but today what we're going to do in terms of examples is we're only going to go over bullish examples we just don't have enough time to go through the mirror image of it from the bear side but once you understand the concepts of the bullish side the bear side will be just as easy to understand you won't need there won't be any additional education that you need to understand the bearer side so when we talk about bullish exposure you really have three choices you can buy the stock you can buy a call uh you know a call debit spread this is what this is the first uh bullish strategy we're going to go over as the vertical spread and then the second bullish vertical spread we're going to go over is selling a put vertical credit spread now selling put vertical credit spreads for any of you that have been members or following options play for a while you're probably quite familiar with them because we've traded a lot of them through our daily plays especially recently when volatility is high and elevated as they are right now it favors selling these types of credit spreads when volatility is relatively low or when we believe the stock is going to make a big move to the upside that's when it makes more sense to buy that debit spread so for example plug power the trade that we put in on monday morning that was a debit spread because we felt that plug power had the potential to make a big move and that's exactly what we saw here today and i'm glad we used the debit spread and not a credit spread because if you sold the credit spread you wouldn't have been able to participate on that so those are some of the things we're going to go over here today now on the bear side of things uh what you're going to see is that you can short the stock that is the simplest opt uh you know that's the only stock strategy that you can trade if you're bearish on a stock and then what we're going to do is we're going to uh look at buying a put debit spread and or selling a call credit vertical spread so like i said today we're not going to cover those two strategies but again those are just mirror images of what we're going to take a deeper dive into here today so for the first example what we're going to do is we're going to look at a bullish strategy now before we dive into debit and credit spreads we're actually first going to look at single legs because once you understand the single leg you're going to understand the debit spread so for those of you that are new to options or new to to trading multi-leg options don't worry what we're going to do is we're going to take it one step at a time start with single leg make sure you understand that and then progress it to the multi-legs and what you'll see is that the multi-legs really they're not too complicated they're just a slight improvement of the single like strategies okay so before we get started can everyone please bring up your chat window which is at the bottom of your screen and please type one into the chat window if you're just in the learning process of how to trade options and please type two into the chat window if let's say you have experience trading options okay so i see a lot of twos but i'm seeing plenty of ones being put in there in between the twos so most of you have experienced trading options but again for all of you that have responded with one this is going to take it one step at a time starting from the beginning and then if you're an experienced options trader i really think that you will learn something uh regarding these types of strategies that will improve your ability to use these strategies so first off we're going to use stock xyz trading at 100 and i believe that this stock is going to go higher maybe i think the stock is going to rally to 110 right so i think the stock's going to go higher so what can i do as a stock investor i would buy the stock as an optional investor the first strategy that i would look at is buying a call option so let's say i buy a call option i buy a 100 call option the at the money strike price and i pay four dollars for that call option now when you learn about these types of strategies you learn very quickly that when you buy a call option you get unlimited upside so as the stock keeps going higher and higher and higher you make more and more money but the flip side if you're wrong on your strategy the most you can lose is the four dollars that you pay for the call option and this is what we call an asymmetrical risk meaning unlike stock trading that has symmetrical risk for every dollar the stock goes up you make a dollar for every dollar the stock goes down you lose a dollar when you're trading options it's not symmetrical it's asymmetrical and it works in your favor when you buy an option like a call option where if you get the direction right you can make more and more money as it keeps going your favor but if it goes against you the most you can lose is four dollars a share in this particular case and that's really what attracts a lot of investors to looking at these types of strategies being able to leverage your capital right controlling a 100 stock for just four dollars and then doing so uh where if you're right you get leverage your capital and if you're wrong you only risk four dollars a shift doesn't that sound fantastic why wouldn't we all just buy call options when we're both when we're bullish on a stock and never buy the stock ever again because when we bought a stock you're risking a hundred dollars a share and the answer is that it's not that simple because when you buy a stock the second the stock goes higher you start making money but when you buy a call option it's bullish by a certain amount and what i mean by this is that your break-even point of an option is actually the strike price plus the premium that you pay so whenever you buy a call option not only do you have to believe the stock's going to go higher it has to overcome the break-even price just for you to be profitable so in this case if i think the stock's going to go from 100 to 110 then in this particular case because it exceeds my 104 breakeven point i am profitable here so i'm effectively making six dollars if the stock rallies up to 110 while i'm risking in this particular case four dollars if the stock declines below 100. so my potential reward here is up is about in this particular case risking four to make six is a hundred and fifty percent return on my capital if i am correct on this trade now this is just a ten percent move in the underlying stock uh i'm going to make a 150 return on my capital but the challenge here the challenge with the call option is yes you get unlimited upside for limited losses but if let's say you get the directional move wrong i'm sorry if you get the directional view correct but the stock doesn't move as far you can actually get the direction right and still lose money on the trade that's something you can't do when you buy a stock but when you buy an option if you buy a call option the stock can go in your favor but if it doesn't go far enough you can actually lose money on this trade and if anyone has and can relate to that please type three into the chat window if you can relate to that when you bought a call option the stock went higher and you still lost money on that trade that's the biggest challenge with buying a call option now if the stock stays where it stays put you lose four dollars if it goes down you lose four dollars so the reason that a lot of investors you know after a while don't particularly love buying call options is because if the stock goes lower you lose money if the stock stays the same you lose money the stock goes a little bit higher you lose money the only time you make money is if the stock makes a big move here to the upside and if it doesn't make that big move you're likely either going to lose the amount of capital that you put in 100 of the capital that you put into that trade or a percentage of the capital that you put in and that's the biggest challenge with buying a call option richard says it's like buying a lottery ticket not quite but certainly low probability payoff type trades high risk high risk reward meaning if you if you are right you get paid a substantial amount of capital or a substantial return but there's a higher probability that you'll actually lose money on this trade so to understand debit spreads what we want to do is just understand the debit spreads what they're doing is they're improving your odds a little bit on this particular trade now before i move into debit spreads does the call option make sense to everyone please type four into the chat window if that may if the call option makes sense and the challenges with call options make sense to you okay so now let's take a look at debit spreads debit spreads are identical to what i just showed you here before but we're going to make one small adjustment so stock xyz again 100 stock i think the stock is going to go to 110 i think it's going to go higher so what i'm going to do is i'm going to look at buying a debit spread now what is a debit spread made of now even if you know i have no idea what a debit spread is we're going to walk you through this so i'm still going to buy the same 100 call option it's still going to cost me four dollars and if i just buy the call option i have the same challenges that i had before but the one thing that you'll remember is that when you buy a call option what you're buying is unlimited upside you're basically saying that in theory this i believe the stock could go to 200 or 300 or 400 and remember there's an expiration date it has to make that move before that time so whenever you have an expiration date you can also make some calculations as to okay you know between now and let's say two months from today maybe i don't think the stock maybe i think there's no chance the stock's going to be at 130 140 150 so why should i pay for all that upside and this is really the beauty of options because you have number one a lot of options and you have you can get really creative with what you can do with all of those options and the debit spread in my opinion is just the first example if you're brand new to option strategy the first example is how you can take some of this creativity and use it in your favor okay so when i buy a call option i'm buying unlimited upside but why should i pay for that if i don't think it's going to happen anyway and this is really where when you're trading options you can do something about it you can say okay i'm going to buy the 100 call option which gives me unlimited upside but i'm going to sell off some of that upside because i just don't think the stock's going to go to 120 or 130 between now and two months from today so let me sell off some of that premium let me sell off some of that upside and exchange have someone else pay me a premium when you buy a call option you have to pay but when you sell an option you get you get paid now when you sell options there are other complexities here but when you're buying an option you're effectively hedging that risk that you're just selling on the on the short option and that's really the beauty of options is when you can offset your risk and offset your your risk that's really where you can um pay some dividends here so in this particular case what i'm going to do is i'm going to sell the 110 call option basically saying i don't think it's going to go above 110 so why should i pay for that collect one dollar for it now what i'm doing is i'm effectively buying a very similar upside as i was doing before on the call option i get very similar upside but my risk is now just reduced from four dollars a share to three dollars a share now this doesn't change the thing from day to night but it does shift the pictures quite a bit before the stock had to go above 104 before it's profitable now it only has to go above 103 and it's profitable so i have a higher probability of profit and what i've done is i've just exchanged my upside above 110 in exchange for this one dollar something that i don't think is going to happen anyway so now what i've done is i've reduced my mattress to three dollars i've capped my max reward to seven dollars um and what this means is that if i do get the move from 100 to 110 that i anticipated what i'm making here in this particular case is seven dollars versus the three dollars that i'm risking now a seven dollar profit off of a three hundred three dollar uh trade or three dollar risk is a 233 percent return so basically if the stock makes the 10 move that i'm expecting it to make over the next two months and i traded a debit spread i would be looking at a 233 return versus the 150 return before if i had just bought the call option before if you i showed you with the call option i'm making 150 return on that option here i'm making 233 so i've reduced my risk because i've reduced from four dollars to three dollars i've increased my potential reward because i've reduced my risk and number three because my break even price is now at 103 i have a higher probability of success because the stock doesn't have to move as far before the strategy is profitable so that is where you can take a look at these types of strategies and understand why someone wants to trade a debit spread it's really just taking a call option and improving the risk reward ratio a little bit improving your potential return and improving your potential for profit does that make sense everyone please type five into the chat window if that makes sense to you okay so that's the key of a debit spread now let's flip this on a dime let's talk a little bit about selling options before we jump jump into the credit spread so selling up so right now again stock xyz trading at 100 i think the stock is going to go higher now when you sell a put option it's a little different than buying a call option but your risk profile is very different but your but your views on the stock are fairly similar so when you sell a put option even though technically it falls under the bullish category uh i think the most the more accurate description of what selling a put option is is when you're somewhat bullish but not too much meaning you think it's going to go a little higher but you don't think it's going to go a whole lot higher that is when you want to sell a put option um and i think i'm good and i'll show you some examples of this in a little bit um but in this particular case if let's say i'm somewhat bullish but not too much what i can do is i can sell a 100 put option in this particular case let's say i collect four dollars in terms of a credit now what happens when you sell a put option is that as long as the stock stays above the strike price that you sold you're gonna keep the four dollars so if it stays where it is or moves higher you keep the four dollars now if the stock goes below your strike price the further it goes lower the more you lose and technically there's no there's even though technically there is a limit to how much money you can lose because the stock can't go below zero but i still like to think of that as unlimited downside because in theory the stock can go all the way to zero and the further it goes down the more you lose there's no it's not like at some point you stop losing money per se it's just that when the stock goes to zero you can't lose any more than zero so from my perspective i still call that unlimited downside um so as you can see here a lot of investors when they first look at this type of strategy they say well why would anyone want to take on 400 worth of potential reward and in exchange for that take on unlimited risk that doesn't make a lot of sense and the answer is sure you know in many cases it doesn't but the one thing you have to remember is the the attractiveness of the strategy is before when we talk about a call option if the stock stayed the same the stock went lower the stock went a little bit higher you lose money in a lot of different scenarios only if the stock makes a big move to the upside do you make any money now when you sell an option the exact opposite happens if the stock when the stock's trading at 100 i think it's gonna go higher right if it goes higher i make money but if the stock doesn't move at all if it stays at 100 i make the same amount of money i still make the four dollars if the stock goes against me even if it goes down to 98 guess what even i got the direction wrong i can still make money on this trade if the stock goes to 96 i actually still don't lose money on the trade i've broken even on this trade i only lose money if the stock makes a big move to the downside and many investors when they trade this type of strategy they're making some calculations they're basically saying okay i don't think the stock's going to zero anyway but there's a possibility that maybe it goes down to 90 right so if i get this complete if i get this wrong the stock goes down to 90 then i'm not risking unlimited amounts of money what i'm really risking is in this particular case let's say six dollars in exchange for making four dollars if the stock stays higher stays the same or moves a little bit lower does that make sense everyone please type six into the chat window if selling a put option makes sense to you okay so it's not the it's not the it's not the best strategy per se because you are ultimately still taking on this this unlimited downside right and we never know what can happen the stock can have a bad earnings the stock can make a big move to the downside on some news so the reality of what stops many investors from selling put options is this fear of having this unlimited risk and that's where credit spreads come in credit spreads again allow us to use the creativity of options to offset some of this so in this particular case same example stock xyz 100 i'm bullish on it but not too much meaning i think it's going to stay where it is move a little bit higher i don't think this is the type of stock that has the explosiveness like plug power does i just think that it could make some slow moves to the upside maybe this is like a walmart or you know that type of blue chip stock you don't think it's going to make a big move so what you do is you sell the 100 put you collect the four dollar credit but again because you don't want to take on unlimited risk what you can do is you can buy a lower put so again we're doing the same thing we're selling this 100 100 put in exchange we're collecting four dollars so if the stock goes higher i make money and then but because i don't want that unlimited risk factor what i'm going to do is i'm going to buy a lower put when i buy that lower put what that does is it offsets the risk of the long put anything below 90 whatever i lose on the short put i'm gonna make back on the long point so that's really how a credit spread works you're basically have this very similar risk profile is selling the put but you're you're you're cutting your losses to the downside if it makes a big move to the downside so what i have to do then in order to sell the credit spread is that i do have to pay one dollar for this 90 put what that does is it reduces my total credit on the trade from four dollars a share that i had before now down to three dollars a share so i'm i'm giving up a little bit more of my credit so in this particular case if the stock goes higher i still make money i just make less money here in this particular case i only make three dollars if the stock stays exactly where it is i also still make money but i just make a little less i make three dollars instead and now my break even price before was 96 now it's 97 so i have a slightly smaller buffer to the downside for the stock to go lower but still be profitable but in exchange for that one dollar in potential reward that i give up what i gain in conjunction for that is i no longer have this unlimited risk of the downside so if you are you know in the back of your mind concerned what if i wake up one morning and this stock's down you know at 50 bucks you don't have to worry about it by buying that 90 put no matter how far the stock goes below 90 even if it goes to zero you cannot lose more money on this particular trade so that is the anatomy of a credit spread you're really just taking a short put or a short call and improving it slightly by uh buying that out of the money call or put by reducing your risk does that make sense everyone please type seven into the chat window if that makes sense to you okay perfect so in this particular case before we go any further i do want to go through a real example because uh you know we've gone through xyz i think you guys understand the concept but i think the best way to learn always is using a real example here i'm gonna use apple here because apple's made a pretty nice run recently from 113 to 138 or so pulled back all the way down to 126 roughly a 50 move to the upside and is now starting to resume its way higher here so let's take a look at a few different examples of how to trade this particular strategy and what i'm going to do is i'm going to use this to set up a credit spread we'll use let's say a 130 and i'll show you why i'm using the 130 120 in a little bit so what i'm going to do is i'm going to compare selling the credit spread to buying a debit spread um and so the best way to take a look at this is you know apple's trading currently at around 130 131 or so so let's say i think the stock's gonna resume back up to let's say it's 138 uh region in this particular case so from my perspective you know apple's currently at 131 i think it's gonna go up to 138. that for me is not overly bullish that's mildly bullish so right off the bat just on that alone i think i would prefer to trade the credit spread now if you are in the camp that you believe that apple is going to exceed that level and greatly exceed that level that's when theoretically you should be looking at selling buying the debit spread but let's compare the two side by side and i think that will help solidify um you know understanding these types of strategies so we're going to use our p l simulator this is the tool that you have access to here at options play you can type in any strategy use the um strategy constructor you can construct any strategy that you like i constructed a short put vertical here and we're going to use our p l simulator to compare the two strategies now i always tell investors before you trade any type of strategy before you look at potential reward always look at what the risk is look at if you can handle the risk because a lot of investors you know unfortunately and unfortunately with options i see too many investors jump into strategies not really truly understanding you know their risk hoping to figure it out as they kind of go along not knowing how much risk they're taking i never ever advocate for that always understand your worst case scenario how much you can lose on a trade and ask yourself before you get into that trade if i was to lose a hundred percent of the max loss on this trade would i be comfortable in my portfolio or would i have suffered such a big loss that i would have trouble to continue trading i've seen too many times where traders trade way too large not not really thinking about their max loss thinking that that's not going to happen to me having their account effectively blown up as a result of it and that is you know no one wants that so please always look at your worst case scenario first under ask yourself am i comfortable with it if it is then proceed with looking at potential reward um so here uh you know as i said if let's say i'm just dead wrong on apple and it returns back to 115 maybe markets get a little jittery we sell off to 115. here on the credit spread i lose 607 on the debit spread i lose five hundred and sixty four dollars the the the two are very similar to each other in terms of max risk here it's only within you know 50 bucks or so of each other so the two have very similar risk profiles now let's take a look at well what happens if apple just stays put let's say it doesn't move at all you know i think it's going to go higher but you know over the next couple of days it goes a little higher goes a little lower and ends up a couple of you know weeks later here at 1 30. now if we hold this to x no this is assuming we hold the expiration we can choose you know different dates before expiration but you can use this and see you know how these strategies perform we're going to use expiration for now just to make it easy to compare so if the stock stays exactly where it is as you can see if i sold the credit spread here i make a hundred percent of the profit 393 dollars what the amount of credit that i sold the credit spread for i'm selling it for 3.93 my risk is 607. here my risk is 564 but my potential rewards 1236. so if the stock stays where it is i'm far better off selling the credit spread right now the stock moves a little bit higher i said what if it revisits its all-time high around 138 now as you can see here the credit spread still makes the 393 that's the full credit that i receive on the debit spread i only make thirty six dollars which is a twenty four percent return remember the two have very similar risk profiles so i think i can actually compare the profits against each other uh one is making me for almost four hundred dollars the other one's only making me 136 that's why again the challenge with buying a call option or call spread and if you just bought the call option notice here if the stock went from 131 to 138 you would actually lose 10 of the premium that you paid that is the worst part about trading options is getting the direction right but then losing money on the trade because you chose the wrong trade structure so it's very important to understand these trade structures even if you're not trading it just so that you can better understand how to utilize options for your portfolio so if the stock goes higher to 138 here you're still going to make the full 400 here you make 136 but what if it goes higher let's say it goes to 145. now notice how that you know six dollar difference here in the underlying stock makes such a big difference remember when you sell a credit spread the most you can make is the credit that you receive and this becomes this becomes your limiting factor when you sell a credit spread and that's why i tell investors don't just sell options all the time or don't just buy options all the time you know i had a a couple of investors ask me questions over the past few days you know i heard somewhere that you know you should only sell options because that's where you make the most money or that's where you can make money more consistently and the answer is true yes you can make more money more consistently selling options but you're also very limited in terms of the amount of potential that you can make when you sell options and this is an example of this if the if apple does make a big move here to the upside here i'm making 836 for the 500 that i'm risking so i'm making more than 100 about 150 return on my capital and if it goes even further the more it goes as you can see here here i'm only making the 400 versus here i'm making over 200 return on the 200 on the uh 1200 on the same 564 of risk so this is how you can use the tool of options play to plug in any symbol that you like whether it's apple or walmart or something more exotic or you know volatile like meal which is one of the stocks we'll cover tomorrow morning during our electric vehicle um a session use this tool to set up various strategies modify it create a a credit spread here um and and see for yourself you know how you want to select uh you know comparing the debit versus credit spreads and and use the p l simulator and see how they perform see where you make money see where you can make the most money based on your outlook on the underlying stock that's why we built this tool because it's one thing to learn it it's a whole other thing to be able to implement it on your own so hopefully this gave this gives you a little bit of a glimpse into how you can utilize options to our options play to analyze these types of strategies and decide for yourself what strategy is best so let's talk a little bit about how to construct these strategies now when you're using a debit spread we usually tell you to use an expiration date that's roughly 60 days from expiration as your starting point that's where you want to start 60 days from expiration and what we the two legs what you want to do is you always want to buy the at the money call option and sell roughly a 20 delta call or put against it now if you're using the options play tool when you click on the modify button and you use the strikes as you can see there are three numbers you have your strike price the premium and you have your delta so you can use this to help you select your strike prices the 50 delta is the at the money call or put the 20 delta is roughly one standard deviation away and we we always pick the one standard deviation away so that you are roughly selling something that has a only a 20 chance of the stock being above or below those two prices and we do that on purpose because we're trying to maximize the premium that you collect while minimizing the risk of the stock blowing through those strike prices so if you use this type of strategy as 50 20 debit spread the premium that you collect on the short leg will usually offset roughly 20 percent of the premium the long legs so what you're doing is you're actually reducing your risk by about 20 percent compared to outright buying the call or put and that 20 will magnify your returns um so that's generally speaking what we consider the optimal debit spread it's important to understand you know how the the relationship between debit versus credit spreads and i actually have another slide here to talk about that relationship on the credit spread side we it's a slightly different number one we usually go about only 45 days out because when you're trading a debit spread you're predominantly long the option that's that's the main leg if you will as you're along that call or put and whenever you're long a call or put you want to reduce time decay one of the best ways to reduce time decay is go further out in terms of expiration that's why on the debit spread we start 60 days out but on the credit spread your main option is actually short a call or a put and when you're short of call output you want to maximize time decay the best way to do that is selling shorter data options so that's why we shift the expiration date between debit versus credit 60 days per debit 45 days for credit now on the credit spread we also sell the at the money call or put so roughly a 50 delta caller put and we usually buy back about the 25 delta call or put and the ratio that we're looking for here when we sell it credit spread is that the credit that you receive should roughly be one third of the distance between the two strikes now so when you're looking at a credit spread here when i talk about the distance what i'm referring to is the difference between the 54 and the 48 so in this particular case that's six dollars wide the difference between 48 and 52 or 54 i'm selling the 54 put i'm buying the 48 so the distance between those two legs is six dollars what i'm trying to collect is roughly one third of that in that particular case would be two dollars here as you can see i'm collecting 2.65 cents anything greater than one-third would be better for your credit spread so whenever you're collecting less than one-third that means you're taking on too much risk you want to collect at least one-third of the width here here i'm collecting even more than one-third of the width here so you know we always this this chart here on the left is just giving you a sense for you know depending on how wide the credit spread you're selling the amount of credit that you're trying to collect off of it this is just a simple rule of thumb here to give you a sense for whether you're selecting the right credit spreads and you know at the end of the day to really understand the difference between the two you know i get a lot of comments from investors people will tell me you know i hate debit spreads because they have such low probability of profits i think there was a couple of other questions here about probability of profits i will address here during our q a session but you know what we want to talk about is the fact that a lot of investors look at this number and they say oh a debit threat at such low winners i don't want that i want high winners let me sell credit spreads so i unfortunately see too many investors where they only sell credit spreads because they think in their head oh that has higher probability higher probabilities always better right if i can win more often that'll be more profitable but most investors actually forget that whenever you trade any option strategy there is a trade-off between probability and risk for reward and the two counteract each other whenever you have high probability you're always going to have poor risk reward on the flip side if you have low probability you're always going to have high risk for reward or better risk to reward so the one is not better than the other you just have to understand that you are on opposite ends of the spectrum now one again one is not better than the other you just have to understand the characteristics of what you're trading whenever you trade a debit spread yes you are going to win less often you're going to have more losers when you trade debit spreads and a lot of investors don't like that but when you are right you get rewarded for it in that apple example i'm taking on 500 worth of risk if the stock makes a big move to the upside i get rewarded for that i get paid a substantial amount of return on my on my on my um trade when i sell a credit spread yes i win more often but even if the trade goes it makes a big move in the direction that i expected to my reward is fairly limited in comparison to the total risk that i'm taking i'm always taking on more risks than i can potentially make so that's a trade-off that you're making and it's important to remember one is not better than the other it's just the trade-off that you're making does that make sense everyone please type eight into the chat window if that makes sense to you because this is really at the crux one of the most important lessons to learn when you're thinking about credit versus debit spreads i get so many questions from investors saying which one's better debit or credit the answer is that one is not better than the other they're so different from each other and the characteristics are very different so let's talk a little bit about trade management right once you're in one of these trades how do you manage them and this is really where debit spreads in my opinion are easier to manage they're simpler to manage because the rules for managing them are really really simple when you buy a debit spread you pay amount of capital to get into that trade and all you have to do is monitor how much that debit spread is currently trading for just like how if you buy a stock for ten dollars if the stock goes up to 15 you sell it if it goes down to five you sell it you know you have these rules as to when you want to sell it um when with the debit spread it's exactly the same you want to exit a debit spread upon the trigger of either signal and there's only two possible exit signals on a debit spread either stop yourself out when you've lost 50 of the premium that you've paid so in this particular case let's say i buy a debit spread and it cost me three dollars to get into the trader 300 dollars to get into the to the full contract now if i if i pay some something if i pay three dollars for something and i lose fifty percent of what i paid then it's time to cut your losses and get out so if you pay something three dollars for something and it's now trading at a dollar fifty it's time to cut your losses and get out of the strategy on the flip side if you buy something for three dollars and it starts to go in your favor meaning it starts to increase in value you want to start taking profits at about 75 to 100 percent of the premium that you've paid so plug power this is the trade that we entered on monday this is a debit spread we are just shy of that 100 goal here on plug power in just four days of trading now this is um it's unusual that you get that type of return in just four days but this is an example of where it's time to start taking profits now you know for those of you that are a little bit more advanced you might remember i've recently recorded a video on uh rolling uh these types of spreads to turn what is a small winner a 100 percent gain into maybe a 2 percent gain by rolling these types of strategies so that is another thing that you could do but that's not what we're talking about today this is more of an introductory video for those of you that want access to that uh rolling video i'll link to it um in the youtube uh for the recording but this is really where you want to start taking profits or consider rolling these particular strategies when you reach about 525 to six dollars which is 75 75 to 100 gain on the on the um debit spread now on the credit spread this is where it's a little bit more complicated it's not overly complicated but it is a little bit more complicated which is the fact that you have three signals that you that you three things that you have to monitor for for potential exits whichever one of these three triggers first that is your signal to get out of the trade so let's say in this particular case i sell a five dollar wide credit spread so the the distance between the two strikes was five dollars and i collected two dollars off of that five dollar credit spread now when do i exit the credit spread there are three rules to exiting the credit spreads i'm actually going to cover number two and number three first so when i sell something for two dollars remember a credit spread i want this to basically go down to zero so the most i can make on a credit spread is the two dollars that i collect now we generally tell you to take profits at fifty percent of the max gain so if i sell something for uh two dollars and now i can buy it back for one dollar it's time to take your profits and get out of the trade keep your profits go if you can keep fifty percent of the profits now if the trade goes against you meaning the spread that you sold now increases in value to 100 of the max gain so if it goes from two dollars to four dollars that's when you want to start cutting your losses and getting out of the trade now sometimes you don't get to the take profit or stop loss level but the stock but the strategy that you sold is now at 21 days to expiration that is also another trigger to get out of this trade the reason is because whenever you're selling a credit spread you don't want to generally hold it in the last two to three weeks um you know within that last two or three weeks because at that point the gamma risk starts to outweigh the theta acceleration that you get now i don't quite have enough time to get into the details of all that i do have a separate webinar on credit spreads as well if you want to look at that um again i'll link that in the youtube description um but those are really you know the reasons why we don't want to sell credit spreads in or hold credit threats into the last couple of weeks and it's so important for investors to keep these types of rules handy whenever you're trading these strategies because i know if you don't have these rules you're going to be sitting there in front of your screen when the stock goes in your favor or goes against you you're going to be sitting there asking yourself should i get out should i stay in should i get out should i stay in and you spend a lot of time emotionally figuring out what to do and it's and it's not a fun process you know especially when you're seeing some losses in your portfolio trying to figure out should i cut my losses and move on and that is what one of the worst places to be emotionally as a trader so i always tell investors have mechanical rules like this and this way you remove the emotional component it either triggers the stop loss or it doesn't and you either just and it's a black and white there's no gray area there's no um there's no emotional ties to it it makes your trading easier when you have these mechanical rules so that's why we have these in place that's why we stick to them whenever we sell you know credit spreads and debit spreads on our daily plays you see that we follow these rules this is also to help you get into the habit of trading these strategies and understanding when it's take time to take profits and when it's time to cut your losses so with that that covers what i wanted to share with you here today i already went through some examples before so i'm not going to go over them right now so at this point what i'll do is i'll open this up for q a but before i do again just a reminder for those of you that are members uh you are already automatically registered for our thematic investment webinar tomorrow morning at 8 30 a.m on electric vehicles all of january we're doing renewable energy i'm sorry green energy so this week we're doing uh electric vehicles two weeks from today we're going to be doing renewable energy so utilities solar wind hydro hydrogen all of those we're going to cover that in about two weeks we're really taking on to this 2021 with green energy giving you a good understanding of the the industry the specific companies within these industries so that you can better inform your longer term views you know a lot of the trades that we talk about here on the daily play are shorter term i know many of you are longer term investors and parts of your portfolio as well that's why we added these thematic investment uh webinars to give you more uh content on that front so looking forward to seeing our members here tomorrow morning on that so with that you know if you don't have a membership yet and you want to attend tomorrow morning session you can register right now uh using the link here on your screen at trade.optionsplay.com member membership is just 75 a month or 500 a year or if you've never signed up for an options play account either you have a free 30-day trial you can register for it at optionsplay.com it's going to give you access to the s the trading signals that has the debit and credit spreads that we send out every single day includes education like the one you're on today and as well as access to the options play tool which i just showed you how to analyze debit versus credit spreads with so that is all accessible either as a member or as a free trial by signing up using that link so with that what we're going to do is we're going to open this up for q a i'll try to answer as many questions i have time for here today so there are two buttons here at the bottom of your screen there's a chat window and a q a window please bring up the q a window and i will answer your questions out of the q a window so if you have a question about options please type them into the q a window and i will um answer your questions out of there so you know a lot of questions regarding replays we always send out the replays about 30 45 minutes after we finish each day so um yes the recordings are going to be sent out to you so please type your questions into the q a window here let's see um are credit and debit spreads better suited for bull markets versus bear markets so it really has nothing to do with bull markets or bear markets at all it really just has to do with your directional view of the market so you know bull markets and bear markets are more do you want to trade bullish strategies or bearish strategies you obviously generally heavily trade bullet strategies in a bull market and bear strategies in a bear market has nothing to do with debit versus credit spreads um blair is saying tony why not buy more time the money on longer term is not that much greater so blair you know great question blair blair's asking you know why do we buy let's go back to the apple example and blair this is actually why i'm doing the session next week on diagonal spreads blair is basically saying if i buy you know let's say a march 130 150 for six dollars and 31 cents why not buy uh let's say a june one for 940 dollars and basically buying double the amount of time for only uh you know 50 percent of more more more premium the answer uh blaire is because whenever you sell a long dated option you're not actually benefiting from the time decay because the long dated options yes you get the benefit on the long side but you're not getting the benefit on the short side that's why if you want to go longer dated there's nothing wrong with that but you still want to sell a short dated option against it so you might want to sell the one you might buy the june 130 calls but you only want to sell the february 150 calls against it you're actually going to collect more premium by selling shorter dated options more often than you would selling that long dated options going further out so that's actually what i'm going to be covering next week on the calendar and diagonal spreads uh shall i wait for next mark next markets crash before start placing long-term trades um you know at the end of the day i'm not a cure to tell you how you want to position your long-term trades and i guess long-term is also very subjective you know if you're talking about trying to invest for the next two to three years perhaps um but you know the next market crash could be two years from now and you know are you willing to give up the gains for the markets over the next two to three years waiting for that crash you know maybe that crash doesn't materialize for another four or five years you know it's really hard to to see uh so that's my you know take on whether you should wait um on you know as a general rule of thumb yes you know buying long-term plays on a market crash is certainly going to be better on debit spreads are we basing stop loss on premium loss and not on specific level of the chart yes so when you're trading a debit spread your cred your criteria to cut your losses is based on the premium of the of the of the debit spread that you pay not on the chart of the stock itself uh good question andrew is asking what would be the ideal percentage of credit to receive for a calendar vertical spread many things um so i i guess if your question is you know on a if a debit spread you collect 20 of the long legs premium uh the calendar spread you know it really depends on how far out that you're buying or the difference between the expirations you know if you're buying a three option and then you're selling a one-month option against it you're obviously going to collect a much smaller percentage so it's hard for me to nail down a specific percentage um but i think one of the things that you can do is look at a you know let's say we're selling and we're trading a one-year debit spread break down that the short leg into 12 pieces and make sure that what you're selling in that one month is greater than 1 12 of that one year option you will generally tend to find that you can almost double the premium by selling one month options 12 months out you know for 12 months then you could selling one 12 month option so you know that's a general rule of thumb that you can use but i couldn't nail down a percentage uh frederick is saying how do we interpret the options place score great question the options play score is designed let me just go back to the long call vertical here for one second the options play score is designed to give you a better sense for the risk to reward the amount of red how much potential risk you have weighted by the potential reward and it also looks at the probabilities like i said before you know most strategies will look at this and if you sell a credit spread here you know the challenge with credit spreads is that if you sell a credit spread you have higher probability of profit but a worse risk to reward here you have a really good risk to reward but really low probability of profit so how do you tell which one has better risk to reward ratio that's why we created the options play score so that you can have this balanced view of risk reward and probability so that's what the options play score is designed to do again when should i buy spreads 60 days so richard you should if the question is when should you buy spreads you should buy spreads when you think the stock is going to make a big move that's when you should buy spreads if your question is how far out of a spread should you buy yes the minimum is roughly 60 days and saying i noticed you posted short straddles recently please explain the optimal conditions for that strategy so i am going to do a webinar on january 28th on short straddles and strangles specifically you know and for those of you that like to trade iron condors and butterflies iron condors or butterflies are really just an extension of straddles and strangles and what we have produced is a short at the money straddle and strangle report so we're going to be launching all of that together so january 28th is when i'm going to be doing the webinar on that how does trading volume impact the options price jamil generally speaking options volume does not impact the options price very much now if there is an unusually high volume then it could impact the underlying stock price because the market maker needs to effectively hedge using the underlying stock for the trade itself but that is really more of the institutional volume coming in a big order coming in moving the markets but the trading volume itself has no impact in my opinion on the options price now when something trades more often the spreads are tighter but that doesn't affect the options price the fair value of an option is not affected by how much volume is transacted when i sell a put if trade goes against me how can i repair the trade that's like saying if the stock goes if you buy a stock and the stock goes against you how can you repair the stock um you know there's very limited things that you can do to repair a loss i mean from my perspective as a strategist working for the past 15 years i can tell you ninety percent of the of the emotional toll that traders take are trying to figure out how to turn their losses back into gains you know cut that loss move on move on to the next trade you can't win every single trade you certainly can't repair every single trade not without taking on more risk and it never makes sense to take on more risk trying to repair a small loss back into a into a game i can't tell you enough how many account blow-ups i have seen over the years where someone was down a few hundred dollars was trying to do something to get them back to break even you know took on a little bit more risk found themselves down maybe a thousand dollars and then just kept going snowballing from there and turning a few hundred dollar loss into a five ten thousand dollar loss so you know sometimes that lesson can't be learned by me talk telling you that unfortunately this is a lesson that many investors have to learn by going through that process but my best advice to you is if you sell a put and the trade goes against you that means your analysis on that stock is bullish is wrong right you sell a put because you think the stock's going to go higher but instead if the stock if you're losing money means the stock went south that means your analysis was wrong there's nothing there's nothing you know there's nothing to be shameful of that you can't be right all the time you know we're always going to get something wrong and if you can move past that if you can move past the psychology of just accepting the fact that sometimes you're going to be wrong and you cut that loss you know turn that you know take the 300 400 loss move on to the next trade you know that's when you're going to become a more disciplined and a more effective trader in the long run because you're not spending all this time and effort and emotions uh you know trying to figure out how to do this and potentially opening yourself up for much much bigger loss so i know that was a long-winded answer but it was a very very important question for me to answer for so many of you on this webinar that you know are uh you know learning to to figure out how to trade you know and from my perspective you can learn everything there is to know about technical analysis and option strategies and gammas and volatility but if you don't have risk management down you will struggle as a trader so hopefully you know this inspires you to learn a little bit more about risk management i have a lot of videos on it so please take a look at them i hope that they help you in managing risk is the pcc e chart put call ratio helpful um pcce let me see i'm not sure which one pcce is i'll try to take a look uh that's the equity volume traded on sibo um so put call ratios are somewhat useful they they are less i would say they're a little less useful these days than they were before because things have gotten a lot more stretched than we have ever seen you know if you look at the one day put call ratio it's pretty uh low here at about 55 the 20-week ratios at 57 you know 57 is pretty much as low as it's ever been in history um so this is really one of the things where um it's used as a contrarian indicator the question is you know is are put call ratios useful put call ratios historically are contrarian indicators when you have too much call buying that's usually a bearish um you know indicator when you have too much put buying that's usually a bullish indicator so it's useful but you got to take it with a grain of salt you can't just use it in itself to time the markets mark is asking on the credit spreads how would you exercise uh how would you exercise exit the 90 put expiration the stock fell below 97. so mark generally speaking you don't exercise any of these strategies you know the stock goes below 97 you would simply close out the spread as a whole you don't want to exercise that doesn't it doesn't help you by exercising early you don't gain anything from that you actually lose money when you exercise early there's no economic advantage to ever exercising early i'll repeat that again it will never ever be make any economic sense to exercise a call or put early because you are effectively giving away free money when you exercise early the extrinsic value of the option is immediately lost when you exercise a call or put early so never do that always sell the call or put or buy back the call or put as opposed to exercising the call or put why in the debit spread edwardo is asking is it not so important is is it is not so important the expiration date i'm not sure what you mean by why the expiration date is not important i think it is important um you know that when you're trading a debit spread that you use an expiration date that's roughly 60 days out uh charles is asking are the slides available to print charles when you when we send you the recording on the youtube on youtube you'll see the link in the description to download the slides every single video that we put out on youtube has a link to the slides in the description is one strategy better for index versus individual stocks no these are two equally identical strategies whether you're trading single stock or index the one thing about index is that there's no such thing as early assignment there's no early exercise because they're european options so you could say that there's a slight advantage but again there's no economic advantage to exercising early so that's why they don't happen very often sergey is asking why your spread sometimes very wide it is very risky strategy in my opinion sergey we don't determine the spreads the market determines the spread so if if you're trading something that's not very liquid spreads will be wider but that's on your choices to what you trade and that's part of why we publish a liquidity list every single day when you look at when you're when you log on to options play at the very bottom of your page there is a link for liquidity now if you want to trade options with the very narrow spreads pick something at the top of the list anything that's very liquid here as you can see right now there are quite a few 315 very liquid names so any of these names in the 315 here you're generally going to see tighter spreads and again you know the the spreads thing you know i've discussed this in one of my webinars on on entering option orders and talking about you know how market makers work and how spreads work um just because you have wide spreads doesn't mean that you can't uh trade in between the spreads i don't necessarily know that you're adding risk by trading something with a with a wider spread since we are in high volatility time why not construct all strategies to profit from vega so here's the thing right you know a lot of investors you know and as much as i love tom sazenov this is the one gripe that i have with him is that you know he teaches the style of trading where when volatility is high you sell when volatility low you buy and those are true statements that you it's best to sell when you when volatility is high it's best to buy when volatility is low but what that mean what you know that conveys is that that's the only thing that's important that vega is the only thing that's important changes in implied volatility but the reality is that huge changes in implied volatility huge exposures to vega only affect your options relatively small but delta changes in the underlying stock price has a much much larger impact on the value of your options so just a few dollars swing in the stock price can turn your stock your strategy from down few hundred dollars to up a thousand dollars but even huge swings in volatility will only affect your option by a few hundred dollars so why do you want to not optimize just on vega alone because vega is a relatively small exposure that you have compared to delta that's why i'm teaching this this course this whole course is based on the fact that yes credit threads are selling in high volatility debits rents are buying in low volatility but despite those two things despite having a different vega exposure the biggest exposure you have with these two strategies is still delta always think about your directional view first where do you think the stock's going to go because if you think the stock's going to make a big move no matter how high the volatility is you're better off buying that debit spread so delta trump's vega so yes vega is important but delta always trumps vega i hope that clarifies that for you carrie in terms of recommendations not for do you decrease risk by selling below the current market price um i'm not sure what you mean by do you decrease risk by selling below the market price if the question is do you reduce risk by selling a credit spread where the or the um uh it's lower the answer is sort of not really because um your break-even price so let's say before right before in the example we were doing we're selling the 130 120 right the break-even price of that is 122.55 126.55 so as long as apple stayed above 126.55 i am profitable but the max risk on this particular strategy is 655 so the question that gary was asking is if i move this strike lower do i take on less risk the answer is not really because yes your break even is lower here my break even is 122 so as long as apple stays above 122 i can be profitable but i've taken on more risk before i was trading i was risking 655 dollars here now i'm risking 758 so i'm risking a hundred dollars more in exchange for roughly four dollars of of movement in an apple stock so if apple moved forward i have a four dollar buffer a slightly bigger buffer but if it exceeds that buffer i'm losing more money so you're not really reducing risk actually the further you go down the more risk you're actually taking um so that's why we never sell these really far out of the money credit spreads you never want to be in the position where for fifty dollars worth of reward you're taking on nine hundred and fifty dollars worth of risk that's what we call picking up pennies in front of a freight train uh mitchell is saying do you ever buy back the short position of the of the long skyrockets um so mitchell generally no you know plug power is probably an example of this you know where we you know now it's up 106 it's above the strike price um we're above the 45 call option here and and um mitchell's question is do we ever buy back the 45 call the answer is no one number one to buy back the 40.45 call right now will be extremely expensive and if let's say tomorrow you did that and the stock plummets you would then lose all the money in the long leg so you would effectively have lost more money than the match risk that you would have had if you stayed intact or if you didn't break up the two legs so for those reasons i generally will not break that up credit spreads do you close both legs same time yes you close both legs at the same time for both debit and credit spreads douglas is saying hi tony do you ever consider putting on both a credit and debit spread at the same time on the same stock douglas i would say that i don't um you know that's kind of what they call a double double uh double vertical spread i believe um you can do it i don't see a strong advantage to doing it um but you can because you're effectively negating a lot of the um the benefits of it you know i think so just to show you here you know from my perspective why i don't think it's worth doing uh what you're better off doing in my opinion so here's a short put vertical let's say i sell the 130 uh 120 vertical spread and then i buy let's say a 130 uh 150 call spread right that that is a you know you can change these strike prices a little bit if you'd like just so that you're not overlapping strike prices but as you can see this strategy this this vertical spread spread that's actually what it's called when you sell a put credit spread and buy a call debit spread at the same time notice how that is almost identical to this particular trade the 120 150 notice how the two have almost identical trades almost identical amount of max reward identical amount of risk one is four legs one is two legs the four legs are going to cost you double in terms of transaction costs it's going to cost the double number of contracts you're going to have to trade trade the paid the spread four times so from my perspective no advantage of trading four legs when you can accomplish the same thing in two legs richard should i place a stop loss based on the rules upon entering the position absolutely richard i advocate for that i generally do if i sell a credit spread for three dollars i'll immediately put in my limit order to buy it back for a dollar fifty and place my limit order to buy it back at six dollars or my stop loss to buy it back at six dollars i usually replace you know place that oco order immediately after i put on the trade you know i run a business beyond trading on my own account so i am not always in front of my screen sometimes i'm on a webinar sometimes a minute meeting i want to make sure i get out or cut my losses on the trade so i do have those orders put on how can i use implied volatility to know whether the debit or credit spread is either cheap or expensive um so we have so if you look at the liquidity profile we have what's called iv rank iv rank gives you a sense for whether implied volatility is cheap or expensive so you can actually sort this iv rank of very low like one is very very low so very low implied volatility at the other end of the spectrum here whoops the other end of the spectrum as you can see ark g69 meaning very high implied volatility so this is how you can use implied volatility to tell whether a debit or credit spread is cheap or expensive but the options place score is also here for you the options place score tells you whether you're trading something that's cheap or expensive wayne happy new year thank you wayne if i want to increase my profit potential of the debit spread is it better to widen the leg i'm selling or is it better to keep the sell like closer so if you want to increase your profit potential well there's really two ways to increase your profit potential you know you can either reduce your risk by trading a narrower credit a debit spread or you can go further out in time and give you give yourself more upside it really depends on how far you think the stock's going to go um so you have a lot of choices wayne it's not like one there's only one choice both choices can work it really just depends on whether you think the stock's going to make a big move or a relatively smaller move greg is saying hi tony your options play has app has an excel tab for credit spreads but no equivalent for debits present by missing something um you're not missing something greg the reason that we have a credit spread is because of the fact that credit spreads are very forgiving you don't have to have a strong directional view to sell a credit spread as long as you have a loose bullish or bearish view and you find that you can find a credit spread with very high credit that is worth trading but a debit spread you need to have a stock that you think is going to make a big move and that's much harder to find and that's why we don't have a debit spread spreadsheet because it's it's not easy to find a stock that number one you think is going to make a big move number two is relatively cheap and the debit spread makes sense so that's why we don't have a debit spread because there's really no way to algorithmically identify stocks that we think are going to make a big move those are all hand-picked by us we do a lot of research technical fundamental research to find those types of stocks and you can't just algorithmically pick stocks that you think are going to make a big move it just doesn't quite work that way we've really tried i i i will tell you we spent quite a few months trying to build a debit spread spreadsheet like that but it's just it's impossible to algorithmically pick stocks that we know are going to make a big move that just there's too much uh manual work involved in that process what does the check mark next the options play score mean the question is what is this check mark next to the score mean it just means out of these three strategies which one has the highest options play score when iv is above 100 is it ideal to buy debit spreads so first of all i'm not sure what you mean by when iv is above 100 because iv is a percentage it could be 200 300 it could be any number um you know if we're talking about iv rank you generally want to buy debit spreads when iv rank is between 1 to 10 those are the most optimal or that's when options are cheapest that's the most optimal time to buy a debit spread so below 10 on iv rank is more is optimal for buying a debit spread in the ideas section on the left when you click on a ticker it opens the window but how do you know which idea is recommended some have green check marks but um so jim you don't know that until you click on it because we don't know until until the time you click on it because when you click on it we're pulling the quotes for 3m and then we're calculating what is the risk reward ratio we don't know the risk reward ratio ahead of time because we don't know what the uh you know the options pricing are going to be so that's why it's calculated in real time but if you want to have high scores sort them by by market cap the large and mega cap names are going to have a higher score than the small and mid cap names because small and mid cap names are generally going to be much harder to find ones with high scores do you recommend presetting programming automated exiting trade uh yes again i think i answered that question already as a general rule of thumb is it beneficial to sell four weekly options versus one monthly option a gym in theory yes but in practicality no because number one when you increase your transaction cost four times um that's going to offset any gains that you might get in terms of additional premium or additional theta that you're gonna increase that you're gonna get and the second thing is that when you sell one-week options you have far more gamma risk and that gamma risk is actually going to outweigh the acceleration that you get in theta so for those reasons we do not believe that it's best to sell four weekly options in a row versus one monthly option you're far better selling that one monthly option uh william you know your question about the options play score please send us a question and i'll send you a guide on the options play score if you want to give you a sense for you know a little bit more in-depth understanding uh so tony doing doing longing a bear puts does longing a bear put spread is a debit spread so am i selling this am doing the reverse um a bare put spread is a debit spread um so i'm not sure what you mean by if you're doing the reverse um if you could clarify how does the earnings report fit into the time frame of the option you trade um not sure that i understand your question the earnings report just tells you when the stock's going to report earnings so for example delta airlines reports on the 14th so you would generally use that as a way to determine number one when do you want to enter the trade usually a few days before earnings and what expiration date you want to choose off of that earnings announcement uh or no do you use options in your trading or do you use other vehicles including stocks so i use a combination of stocks etfs and options in my portfolio doesn't call debit spread have a disadvantage of not moving in tandem with strong stock movements unless you are very close to expiration um yes uh but still you know plug you know for example you're still leveraging your capital i'm not sure that that's a disadvantage per se because you're still leveraged um you're just saying that it's not as leverage as if you outright buy a call option but i would say that i would rather take on less risk and give up a little bit more of that upside than necessarily take on more risk just to participate in upside if there's an explosive move to the upside because that explosive move to the upside is fairly rare um and i would much rather give up you know have less risk on every single trade and give up some of that explosive upside and when it rarely happens um you know it's better off in my opinion to take on less risk every single trade um then give up a a little bit and in exchange for that give up a little bit of explosiveness to the upside uh chuck if i have four contract if i have a four contract debit spread and the call side increases enough to buy out the short side of the spread does that make sense to do so chuck you know i i've already covered this before in theory you can be tactical and do it but be very careful because if you buy back that short call and the stock plummets um you will end up taking on more risk than the original max risk of that debit spread please explain the technical score on the chart the technical score is a relative strength indicator so 3m as you can see here barely nudging here barely moving higher here over the past couple of months uh past three four months that's why it has a technical score of four meaning it's underperforming the broader markets versus if you look at a stock like tesla it will have a stock of a strong a technical score of 10 meaning it's outperforming the broader markets so that's how the technical score works to what extent should volume and open interest be considered in selecting proper strikes none whatsoever john the only thing you should be looking at is liquidity liquidity is measured based on bid ask spread not based on volume and open interest the two are correlated but you know you should never pick strike prices based on open interest and volume what someone else trades has nothing to do with what strike prices you should trade um don't confuse the two how many days into it into the trade if the profit target not reached should we close the debit spreads so sanjay you know generally speaking you'll find yourself hitting one of those top profit targets either the profit target or the stop loss you know before expiration but if you find yourself in the last week and you still haven't hit the target or the stop loss that's another time to just cut your losses i'm sorry get out of the trade john is saying i have seen call and put trades be down over 80 and then suddenly the last three two to three days jump to profitability john you're absolutely right that can happen but uh you know once the stock once a a debit spread has lost 50 of its value the chances of it coming back to to break even is less than 15 so you're much better off saving the other half of the premium applying it to the next trade where you have a much higher probability of making a profit rather than holding it and potentially losing the other fifty percent now you're saying that if it gets to eighty percent my point is that you know you shouldn't you should never let a trade get to 80 loss you should cut those losses much sooner so that you don't have those big losses um yes there's always examples of crazy crazy trades that have been down 99 you know with one day to go and all of a sudden gets themselves back to break even or maybe makes a huge amount of of capital there's always examples of that but that is an exception and that is not the rule um so the the numbers are extremely clear on this in terms of cut you're better off cutting your losses rather than holding and hoping that you make your money back michelle is saying you were talking about the plug play how do you manage the fact that the stock has exceeded the price of the upper leg so that's exactly i think this is a great learning moment we're going to exam we're going to teach you exactly how to do it with the plug power so stay with us over the next couple of days i'm trying to decide today whether we take profits on this or roll this or if we hold it for a couple of more days and extract some of the premium on the short leg here so i'm going to be doing a little research this tonight to decide which one's most optimal i'm the holder of a put option of a stock that is going to be delisted tomorrow does the same suggestion to not exercise uh apply um i don't know what you would get if you were to exercise your put but so yes my my comment on on your put option is exactly the same you're better off selling the put option than exercising your put um you're gonna make more money from selling your put option than you would from exercising early uh tom i am presenting at well 365 is it okay to exit each leg of the spread separately you can but i do not recommend it as a general rule of thumb is it beneficial i think i've answered that question what i meant is that in the debit spread we do not have a trigger time to close the trade that's correct but that's because debit spreads are you know are not so the reason that you're you have a time trigger to sell a credit spread is because gamma risk starts to become a problem gamma risk actually works in your favor when you're along the debit spread that's why we don't have the time component of the debit spread why not use out of the money probability percentage in selecting an option it is one of the criterias i found very helpful in strike selection so john the inverse of the delta is the out of the money probability percentage so you can that is what we're doing we're using delta which is the in the money probability percentage but if you use the inverse of that it is the same metric one of my favorite trades has been a call debit spread that is financed by selling an out of the money put which is also known as a call spread risk reversal these are sometimes mentioned as a debit spread with risk reversal any comments greg so yeah uh it's called what we call a a debit of a risk risk call spread risk reversal is what it's called on opposite action um it is a very interesting trade it is one way to offset the cost of the trade so what we're doing is we're saying we're still buying the call spread here but what we're doing is we're going to sell a lower uh strike put against it so maybe you sell a 770 put whoops sell not buy um and that's what the trade looks like as you can see the the the profile of that looks very similar to selling a put option so from my perspective you know um you know it it gives you very similar risk profiles as selling in the money put option um that's the only comment that i have it's not good bad it's just it's a different strategy um okay i really want to get to more questions but i really don't have more time i've already spent 40 minutes on answering questions but i really appreciate everyone taking the time out here this afternoon i hope this is helpful in giving you a better understanding of debit versus credit spreads i answer a lot of other questions regarding options so i hope that i was able to get to some of your questions so with that i want to thank everyone for taking the time out here this afternoon i want i love uh you know to see some of you that are members tomorrow morning on that electric vehicle session i know many of you are looking forward to that so i'm looking forward to presenting that to you guys so have a great night we'll send you the recording as soon as we finish and i'll see you bright and early in the morning have a good night

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Length: 83min 45sec (5025 seconds)

Published: Thu Jan 07 2021