Spread trading is an options trading strategy in which we sell and collect premium by selling call and put options.
Within the strategy we choose to sell spreads on out of the money options, a high probability bet. Our goal is to take advantage of time decay to capture premium on potentially expiring options.
It is very different from directional trading, which requires us to correctly (and thoughtfully) guess whether the market will move up, down, or sideways. With spread trading, we only care that the weekly or monthly options we are holding expire nearly or completely worthless.
Benefits of spread trading
Drawback of spread trading
There are drawbacks to spread trading. We are willing to trade lower risk for lower profits on an absolute return basis. However, because spread trading allows us to create a steady stream of income, that is a tradeoff we are willing to take.
The Explosive Options approach to spread trading:
Here’s what two trades look like in real life:
We sell two 2075/2050 bull put spreads on SPX 500 for $1.75 on a Monday; the spreads expire in two weeks (which means we expect the market to stay flat or rise). We collect $350 for writing this put spread and post a margin of $4,650.
One week later, the market rises a bit and the put spread declines to 40 cents. We send out an alert suggesting you buy this spread back at this price, or $80. Your total net gain is $270.
With the SPX index at 2,165, we use an iron condor strategy. We sell one 2100/2080 bull put spread for 1.20 and one 2220/2240 bear call spread for 1.00, both with the same expiration (in two weeks). The total premium we collect is 2.20.
Seven days later, the index is down to 2,145, the bull put spread is down to 80 cents, and the bear call spread is down to 30 cents. We suggest that you buy this spread back at a 50% gain, or 1.10. We may or may not choose to close it down, but a 50% gain is highly satisfying.