Credit Spreads Versus Debit Spreads
February 3rd, 2010 |
There are plenty of different trading styles out there for every kind of options trader, whether they are conservative or aggressive. So when it comes to trading option spreads, which style of trading suits your potential better as an options trader, selling a spread and receiving an upfront credit for your trade while accommodating risk, or buying a spread on a debit and receiving the potential to multiply your gains? If you don’t know and you’d like to figure it out, ask yourself a couple of simple questions before you decide to go with one strategy or the other.
Do you prefer gathering your gains upfront with a higher chance that you will make money but a lower potential for profit? If you are the kind of trader who likes to trade with probability on your side, then credit spreads are most definitely for you. Credit spreads typically rely on making a profit when every leg of the spread expires worthless. Since around 80 percent of all options traded fall into this category, selling a credit spread definitely means having the wind of probability at your back in a trade.
However, be warned, as since you have the advantage of probability, it usually means that if you are wrong, you stand more to lose than you stand to gain. In other words, losing hurts a credit spread trader more than winning benefits you. You are expected to win a credit spread, and if you don’t you probably did something wrong. Just keep this in mind before you start placing 10 or 20 contracts down and expecting everything to just work itself out.
Or do you prefer making an investment in a trade with the hopes of realizing a profit when you close out your position? If you are the kind of trader who is good at sniping trends and can manipulate on options trade to your benefit in them, debit spreads are most definitely for you. With debit spreads, you make your largest possible loss up front at the start of the trade, so your losses are easy to calculate. And if you manage to win a trade, you can multiply the money you originally invested and make a serious killing.
However, be warned, as since you have the advantage of winnings potential at your side, it means that even if you manage to win a certain number of trades, most trades will be rigged against you and will not yield you a profit. You have to factor in your wins versus your losses when you trade debit spreads, and trust me, there will be a lot of losses.
So before you decide whether you’d rather play a credit spread or a debit spread, ask yourself a few basic questions:
1. Do you prefer greater probability or greater potential for profit when making an options trade?
2. Do you consider yourself conservative or aggressive when trading options?
3. Do you mind carrying risk in an options trade in return for an upfront credit or would you prefer to carry profit potential in return for an upfront fee?
Based on how you answer these questions, you should have a good idea of what kind of spread you should be playing in an options trade. If you are still in the dark and are looking for more education on the subject to give you a more detailed idea on how to trade options and make money, be sure to check out http://www.tamingthemarkets.com
- Eric Conklin
Blogger and Trader
http://www.tamingthemarkets.com
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