Credit Spreads... Up, Down, Sideways... It doesn't matter.

Up, Down, Sideways… It doesn’t matter.

By November 23, 2015Markets, Options, Stocks, Trading

The mental calisthenics to evaluate all of the hundreds of inputs that determine a stock’s price and direction can be exhausting. Trying to forecast is stressful and definitely difficult.

A simple change in perspective and strategy can increase the odds of success from what a stock doesn’t do. 

The three market direction choices of Up, Down and Sideways put probability against you when you select one. The one in three odds is daunting to say the least.

Here what you can do: Use a limited risk option strategy.

If used correctly, this strategy can help you make money based on what the stock is most likely not going to do.

So essentially you are flipping the script by predicting where a stock in not going to go. Think about it… How many times have you been following a stock and you are not quite sure where it will be in 2-3 months, but you almost positive that it won’t be at a certain price in the future based what you know about that stock.

This option strategy is called a Credit Spread. It either involves two call options or two put options, but not a call and a put together. It sounds complicated, but it’s rather simple.

How it works: If you think a stock is going to Down

Let’s say you think a stock is going to trade sideways or go down over the next 90 days, but most likely will not be going up anytime soon. So what you could do is sell a call option that is above where you think the market could go. To protect yourself, you have to buy an option even further away from the option you sold using the same expiration month. This makes it a spread and limits your risk.

If the stock stays below or settles on the price of the call option you sold at expiration you get to keep the money you collected when you sold the spread. If the stock from some reason doesn’t do what you thought it would do and goes up, you can only lose the difference between the two strike prices.

How it works: If you think a stock is going to Up

If you think a stock is going to stay in a range or go up over a certain period of time you can do the same thing mentioned above, but use puts instead of calls.

For example, if you believe a stock you follow is going to do anything except go down over a certain period of time you could sell a put option below the price you think that stock wouldn’t go. For protection, you need to buy a put option that is further away than the option you sold. This make is a Put Option Credit Spread. You make money if the stock stay above the option you sold and lose if it settles below it at expiration.

Go Get Em 

There you have it! When you are undecided where a stock or commodity will go, but are pretty sure where it is not going to go try using a credit spread.


Alan Knuckman

Author Alan Knuckman

Alan Knuckman is the Founder and Chief Market Strategist for a subscription trading service for his inner circle members. He has over 25 years of market experience that began in the pits of the Chicago Board of Trade as a runner and progressed to a Treasury Bond speculator. Each trading day Alan is the video host of the Morning Market Stir from the CME Group and the Pre Market Pulse on CBOEtv. He is also a frequent financial commentator appearing on television regularly with CNBC, CNN, Bloomberg, and Fox Business Network.

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