What Is Credit Spread Option Trading Strategy?

What Is Credit Spread Option Trading Strategy




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What is the Credit Spread Strategy?

The credit spread futures options approach is a simple yet widely used trading technique. It entails purchasing and selling Call or Put Options with the same underlying asset and expiry date. These Options' strike prices provide a profit in the form of a net premium. When both Options expire worthless in an Option credit spread strategy, you benefit the most.

Credit Spread Strategy With Call Option

It means simultaneously purchasing a Call Option with a higher strike price for a smaller premium. A call credit spread option strategy, often known as a bear call strategy, is used in this situation.

Ram, for example, sells a December 2021 Call Option with a strike price of 2,000 and a premium of 400. Simultaneously, he purchases a December 2021 Call Option with a strike price of 2,500 and a premium of 330. Ram benefitted from the differential in the premiums of both Options at the time of this transaction. Assuming the multiplier is 100 since each Option trade comprises 100 shares, Ram will receive a net premium of 70 x 100 = 7,000. Anil will make the most money if the stock price at expiry is less than Rs 2,200. This is because if the price falls below Rs 2,200, both options will expire worthlessly, and Ram will retain the net premium.

If the stock price at expiry is between Rs 2,200 and Rs 2,300, the short Call is in the money, and Ram must sell at Rs 2,200. For instance, if the stock price at expiry is Rs 2,220, the buyer of the first Call Option will exercise their right to purchase at Rs 2,200. On the other hand, the second Call Option in the credit spread method is above the stock price and will not be executed. As a result, Anil will have to face a 2,000 loss. As a result, his net profit will be 7,000 - 2,000 = 5,000. A credit spread approach, on the other hand, helps the investor limit risk by capping the maximum loss. Hence, even if prices climb over 2,300, Anil may exercise his long Call, and his loss will be restricted to the breadth of the spread, or Rs 100/share.

What are the Advantages of Using the Credit Spread Strategy?

One of the benefits of using a credit spread Options trading technique is that it may be employed independently of market price change. By using the proper credit spread approach, you may benefit from whether stock prices rise, fall, or stay constant. Another reason investors like a credit spread approach is that it limits losses. Because the loss in any credit spread strategy is confined to the breadth of the spread, it entails minimal risk. In addition, these spreads are very simple to handle.

Wrapping Up

Contrary to common assumption, futures options trading is not as tricky as they seem. However, you will utilise these cutting-edge financial products more effectively if you have a thorough grasp of them. Having a Demat and trading account is essential if you are trading derivatives or investing in upcoming IPOs. If you don't already have one, go to Motilal Oswal right now and open a free demat and trading account.

 

Related articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | All about options trading in commodities | Futures and Options trading and how to make money | Using options to play a bearish equity market

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