Options traders are usually interested in two things – The amount of capital on risk and the concerned profit potential. Credit spreads work like a risk management tool for options trader. Unlike uncovered options that have a considerable amount of risk, credit spreads are meant to limit the risk and give you a steady source of income. With credit spreads, it is possible to ascertain the risk that’s associated with a given position. In this post, let’s discuss credit spreads in a better way.
Knowing the basics
The basic credit spread is also called a vertical spread, which involves purchase and sale of options in either puts or calls, with the same expiration date but different strike prices. On the other hand, the credit put spread refers to a bullish position, with higher premium on the short put. There’s also a bearish credit call spread, with more premium placed on short call. There are many online sites and resources, where you can learn about credit spreads in detail. Keep in mind that these aspects are determined by many market factors, so don’t believe in spreads suggested by trade gurus blindly.
Knowing the advantages
- There’s no denying that credit spreads do help in lowering the risks considerably.
- The margin requirement is comparatively low, especially if you compare credit spreads with uncovered options.
- You won’t lose more money than the actual margin requirement held in account, which is not true with uncovered options, where traders lose more money than what was the initial margin requirement.
- No matter whether you are focused on debit spreads or credit spreads, the monitoring requirements are much lesser than many other strategies. These are usually held until the time of expiration. However, as a smart trader, you should keep reviewing the spreads, considering the market factors. It is important to understand if hold the spread is wise until expiration.
- There’s no denying that spreads are versatile. The typical strike prices and expirations are varied, and most traders find it easy to strike a combination of contracts that will work for their strategy.
What are the disadvantages?
If you are a trader, who is more concerned about the profit potential, credit spreads might not work for you as expected. Also, a spread needs two options, which increases the commission costs. You cannot always believe the internet or news hype all the time either.
Do your research before taking a call!
Author Bio: Kim Klaiman is a known finance author, who has worked with many blogs and websites in the last few years. She is also an enthusiastic trader and likes to follow the market.