Of all the wealth building strategies (many of which result in disappointment, or worse, bankruptcy), the idea of selling credit spreads is often overlooked. It is does not provide the massive leverage of options buying, nor does it provide obsessive traders with an opportunity to glare at screens, graphs and indicators day in and day out. It is neither exciting or spectacular, but it is definitely not risky (the risk is MUCH less than stock trading) and it certainly is a steady reliable way of building wealth. A properly executed credit spread selling programme can safely turn $1,000 into a million dollars within 4 years.
So, how do you sell a credit spread?
First, you need to have an objective method of assessing the trend of both the market and your chosen stock. There are a number of free services on the web that do this analysis for you, or you can choose to do it on your own with a few simple indicators. It is usually best to analyse the trend of the S&P, because it is the broadest representation of the market. The Dow and NASDAQ are not very representative, but they do provide a glimpse at important psychological factors. Unless your chosen stock is a contrarian stock, it would take a remarkable event for your stock to buck the market trend.
If you want to analyse the trend yourself, start with the market. Look at the relationship between the 10 day moving average (10ma) and the 30 day moving average (30ma). If the 10ma is above the 30ma, then it means that over the last ten days, the stock has been trading higher than it has been trading on average over the last 30 days, and so you have an uptrend. If the 10ma is lower than the 30ma, then you have a downtrend, because over the last ten days, the stock has been trading lower than it has been trading on average over the last 30 days. Apply the same analysis to the stock. Confirm the strength of the trend by looking at the ADX or Wilder’s DMI. If the ADX is above 30, then the trend is strong, and likely to continue. Check the RSI for the market and the stock – if it is between 30 and 70, a trend reversal is probably not imminent.
Secondly, look a month ahead to make sure that your chosen stock does not have an imminent earnings announcement or dividend payment due. If either of those occur in the next 30 days, do not trade a credit spread.
Thirdly, pick your trade type: In a bull market, sell a Bull Put Spread; In a bear market or downward trend, sell a Bear Call spread; for either of these, you should get between 7% and 15% return.
Fourthly, use an options probability calculator (such as the free one available at the Optionetics site) to select a spread with less than 30 days to expiration that has less than 20% probability of ending up “In-the-Money”. Sell that spread.
Fifthly, monitor your trade until it expires, or if the trend holds, buy it back at almost no cost and sell another spread. If the trend splutters or reverses slightly, it really does not matter – you keep your profit until expiration. If there is a major trend reversal, you may need to repair the spread, and worst, you merely make no profit for that month (you will not make a loss either!).
Lastly, Wait for expiration, and do it again the next month!