Hi there and welcome to this article on credit spreads. In a few words I'd like to express the risk involved in this type of option spread just in case you are new to trading options. The reason I would like to bring this up now is because I have had many phone calls from option traders who lost huge chunks of their trading portfolios in October of 2008. Some traders lost up to 80% of their trading capital using this strategy, and the reason is because although this trade has a 90% probability, the risk and the stress involved is not often addressed correctly.
The credit spread is one of the most popular option spreads traded today. The reason is because the credit spread is simple, it makes money over time and it is a trade with a high probability. But this probability rating can be very misleading. The dangers of the credit spread are rarely addressed in books and online credit spread courses. The sad truth is that most people teach the credit spread because it's a good business, but not because it's a good option strategy. It's actually a very risky trade and very directional.
The 90% probability credit spread is very popular on the Internet today. This is a very well-known option strategy. But how much can we make on a 90% probability trade? Usually we can make between five and 10% in one month, but is this really easy money? I think not. Those of you who have traded credit spreads for a while already know what I am talking about. When this trade goes against you, it really goes against you. It's very easy to do a lot of money on his trade.
People don't talk about how they can be way behind on the trade sometimes the whole time they're in the trade. People don't talk about how they get down to the very last day and they are risking 90% just to make a small 10%, and they don't talk about how they can't sleep at night and how they are praying to God that their stock might go up tomorrow. Finally, one of the most important things that nobody tells you about the credit spread is that a 90% probability doesn't mean that you're going to make money nine times in a row and then lose one time. The sad truth is that you might lose 90% on your first trade. This happens all the time.
Credit spreads are actually very directional trades. If you look at a risk graph of a credit spread, then you understand what I am saying. Even though this trade has been on its side, the Gamma is so high that it makes the trade extremely risky. If this trade goes against you, you will lose money really fast. If you are trading short-term credit spreads, and oftentimes you will find yourself at the edge of a cliff and about to lose all of your money.
Finally I would like to say that credit spreads can be used effectively in an options portfolio. Normally, however, the credit spread should be combined with another options strategy. This will limit a risk and increase your return potential each month. There is a place for credit spreads in my portfolio, but if you are thinking of doing them alone as a standalone strategy, then I encourage you to think again.
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