Options trading can sometimes be a very profitable activity, but it often frustrates traders with a continuous stream of losses. The essence of the problem lies in the majority misunderstanding that buying calls is made in expectation of profiting if the underlying stock goes in the preferred direction. This is, unfortunately, a misleading misconception based on which major disasters usually occur.
Most starting options traders share the same frustration: belief that they are doing everything right, buying calls on stocks they expect to rise, yet finding that often their call options lose value even when the underlying stock moves in their favor. It can be incredibly frustrating and is most often the primary reason why traders fail with options trading.
Buying a call option means you’re speculating that the price of the underlying stock is going to move up fairly significantly above that strike price prior to expiration. There are many factors that go into determining the price of an option: time decay and implied volatility could drop the price of the call even if the stock is moving in the right direction. This misunderstanding starts the wheels rolling for what would be a long string of losses as traders continually purchase options without an appropriate strategy or understanding of the mechanics at work.
Thus, understanding options trading requires an essential groundwork in how options work and the available strategies for traders. Many new traders start dabbling in trading options without knowing enough and often rely on the false sense of security that their predictions regarding stock direction are going to create a profit if they do indeed occur.
However, that kind of mindset is going to lead you to disaster, especially when using a one-dimensional type of approach that just focuses purely on call buying. The trading platform does offer different strategies by which one might be able to pick up chances of success, but it is very important to get to know the intricacies involved in those strategies.
One of the best strategies would be the put credit spread, an opportunity to profit regardless of the kind of market and one which is likely to provide profit without the market moving as expected. In this strategy, the trader sells put options while simultaneously buying lower strike puts, thus minimizing the potential risk. It allows the trader to collect a premium upfront, hence all risk remains controlled.
The good news is that there is a way to correct the common mistakes many traders make with options. Shifting your focus from just buying calls to putting in place put credit spreads will greatly improve your win rate and overall profitability.
Understanding Put Credit Spreads
What is a Put Credit Spread?
A put credit spread is the sale of a put option at one specified strike price with the simultaneous buy of another put option at a lesser strike price. It is definitely one of the favorite strategies because it enables you to collect the premium upfront. And since you are making money even if the stock does not move too much in your favor, you can see that trades will be huge hits.
Why It Works
- Low Degree Risk: You hedge against big losses with the purchase of a lower strike put. You know your maximum loss: it is the difference between the two strike prices, less the premium received.
- Winning Percentage: You have a higher winning percentage in an uptrending environment since you can make money as long as the stock closes over the short put strike, even if it does not really strengthen.
How to Put the Strategy to Work
Now, let’s walk through how to successfully implement a put credit spread:
- Determine Market Direction: Before you enter the trade, make sure you are aware of whether you are bullish on the underlying stock based on the market condition.
- Select Strike Prices: Select a strike price for the put that you are going to sell slightly below the current stock price. Finally, select a low strike price for the put you’re going to buy as protection.
- Calculate Premium: You will sell the put and earn a premium; subtract the net premium for the lower strike put. This then is your potential profit.
- Keep Track of Your Trade: Throughout the day, watch what is happening in your stock. If it seems that this stock is going to close below the strike price of the put you shorted, you may want to close that trade early before it’s assigned.
For example, you believe the S&P 500 will not stop climbing. You sell a put option with a strike price of 502 while you buy a put option with a strike price of 500. The puts expire worthless if the market closes above 502, so you collect the premium you received at the start of the trade.
One reason why it tends to give you higher odds of winning and controls your risk better when you employ put credit spreads instead of buying calls outright is that most traders who undertake this strategy report it increases their win rate and actually improves their overall trading experience.
Conclusion
In a nutshell, options trading need not be a losing game if one knows the most frequent mistakes that cause failure. These mistakes: knowing that buying calls will ensure profits are, in fact, the most common pitfalls.
A whole new front will open up when embracing put credit spreads as a core strategy. You can make money in bullish markets with less risk than buying calls. One simple mindset shift increases your win rate and overall options success significantly.
Now that you are aware of the essential elements of options trading, it’s time to implement this knowledge and watch your trading journey flourish. Remember, success in options trading is not just about predicting market movements; it’s about having the right strategies in place to support those predictions.