Sunday, November 13, 2011

Credit Spread - Ouch, That's Gonna Leave A Mark...

By Ted Nino


The Credit Spread option strategy is one of the most popular option strategies available to traders. Unfortunately, it is also possibly the most dangerous.

The problem is that way too many new option traders slap down significant money and start trading credit spreads immediately upon discovering them without first equiping themselves with the proper knowledge and skills needed to trade them properly. They are so captivated by the stories and claims of ten percent months and 90 percent probabilities that somehow they don't stop to think about what they are going to do if their trade doesn't go exactly as planned.

And usually what winds up happening is that the market promptly snaps off their arms and legs, then smacks them across the face with them, then starts to jab them repeatedly in the eyes. In other words - they wind up getting really hurt.

Now wait -

Before you start to get the wrong impression, please, let me clarify something here.

I absolutely LOVE credit spreads. ALOT. In fact, the credit spread is right up there as one of my favorite trading strategies.

And yes - I really do think it's a great and dependable way to trade.

And yes, I absolutely believe all those stories and claims you hear swirling around about credit spreads generating ten percent plus monthly returns and providing trades that have the probability of winning somewhere in the range of eighty to ninety percent. In fact, I KNOW those stories are true because I see it happen all the time in my very own trading account.

The big problem is that there is some very important information being left out of those credit spread claims and stories. Information that I'm sure would keep alot of rookie option traders - who frankly just don't know any better - from blindly making that 'over-confident' leap into the credit spread abyss.

See, while it may be true that the credit spread and iron condor strategies can kick off yields of over ten percent monthly and that they favor the trader by offering high probabilities of winning (in some instances as high as 80 and 90 percent) - what isn't being talked about is the risk to reward ratio of these trades - which can be as high as 10 to 1.

This means that in order to achieve those 80 to 90 percent probability trades - you need to risk ten dollars to make just one - or to be more realistic - you need to put at risk $10,000.00 for the chance to make just $1,000.00.

And as my dear old mammy used to say: 'that smells a lot like an awful bad egg'. Which in fact it is. That risk to reward ratio is nothing but a low down, no good, smelly rotten deal!

Just do the math. With a risk to reward like that, even with the great probabilities and wonderful monthly returns - before long a problem month could come along and completely wipe out your entire account!

Nevertheless...

All isn't lost. There IS hope...

As I mentioned earlier - I really do LOVE trading the credit spread strategy.

It's one of my favorite trades - and it continually generates profits for me.

So obviously there's a way around that horrible risk to reward issue and the inevitable problematic losing months.

And there is.

It all has to do with the management of the trade.

As soon as you discover the 'right way' to place these trades initially - and then how to properly go about managing and adjusting them - that risk to reward dilemma instantly vanishes and goes away.

You just need to take the time BEFORE jumping into the credit spread trading pool to equip yourself with the proper knowledge. A few simple 'tricks of the trade' - so when those problem months DO come along (and they WILL believe me) - you will know exactly what you need to do to immediately squash that threat, easily adjust yourself out of the problem, and experience the Credit Spread option trading strategy for all it's 'really' cracked up to be.




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