What is Spread Trading?

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

  • It can offer a lower risk opportunity as we attempt to capture premium on out of the money options.
  • It is high probability. By choosing trades carefully and monitoring them continually, the probability of collecting the full premium at expiration is high – 90% delta of the entire trade structure.
  • It is short term. Trades typically last 6 – 21 days, which means your capital is continually working for you.
  • It provides opportunities for steady income. By entering a new trade and selling premium on a previous trade each week, you can “ladder” trades and thus create a steady income stream.
  • It offers a nice rate of return. On average, we are shooting for a 1.5 – 2.0% return per trade in our Spread Trader service (on total portfolio).
  • It is an ideal strategy to use when the market is volatile.

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:

  • one

    According to market conditions, we sell bull put spreads, bear calls spreads, and iron condors (a combination of bull and bear spreads).

  • two

    We look for weekly and monthly options with a very low delta – 10 or less. A small delta gives us a comfortable 90% probability that the option will expire worthless, thus allowing us to keep the entire credit (premium) at expiration. (If you want to get into the nitty gritty technical details, we use stochastics and fibonacci levels to find trades.)

  • three

    If it appears we could simultaneously close out a trade and collect premium, we’ll roll out trades to future strike prices.

  • four

    If a trade is not working (and this will happen from time to time – trading is not a game of perfect), we’ll call a stop loss and alert subscribers. Stop loss will be determined on a case by case basis.

    Here’s what two trades look like in real life:

    spread training chart example

    Trade 1

    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.

    Trade 2

    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.

    Get started with EO Spread Trader today!