Credit Spread Options Adjustments
Credit Spread Option can be especially dangerous if you do not have an adjustment plan. Learn about the importance to adjustments with option trading.
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Hi everybody! Welcome to San Jose Options Mentoring Program. In this class today, we’re going to be discussing the importance of adjustments and what can happen to you if you do not know how to adjust your option strategies.
One of the most popular options spreads on the market is the credit spread. In today’s class in particular, we’re going to be discussing the dangers of the credit spread especially if you trade them alone without any adjustment strategy or any other hedging position. In particular, we’re going to be discussing the high probability credit spread. Many traders who begin to trade options, they learn spreads and the first spread they learn is the credit spread. And what are they told? That this is a high probability trade. This is a trade where we can make money if the market stays where it is or goes another direction or even if it drops a little bit, for example.
New option traders, they’re not aware of all the risks in this particular strategy and we’re going to be focusing on that a little bit today. What we’re taught in our early learnings of options, what we’re taught is that the credit spread is a very high probability trade. For example, you may construct a trade with a 90% probability or an 85% probability. In this type of trade, you can make 5-10 possibly 15% return, depending on the premium that’s presented at the time. But there’s one thing that nobody really talks about and nobody really tells you and that’s what I’m going to talk about right now.
Let’s consider a high probability credit spread, what does this mean? This means that our probability of making money on the trade is extremely high, 85%, 90%. So this is great, we are constructing a credit spread with a 90% probability at making a profit. What does this mean exactly? Well, this means 9 out of 10 times, we can make money on the trade. Nine out of 10 times, we can make 5 to 10 to possibly 15% on the trade. That’s what this means. But guess what? There’s something very, very, very important that they don’t tell you. Guess what that is?
This is what they don’t tell you, I have to highlight this in orange or red, this is what they don’t tell you, in the credit spread, sure you can make money 9 out of 10 times but not really. Just ‘cause it’s 90% doesn’t mean you’re going to make money 9 times and then you have a losing trade. You can lose 90% on your 1st trade. What if this happens to you? What if you have $100,000, you start trading credit spread, you put your whole portfolio in the credit spreads. In the very first month, happens to be that 10% of the time when you’re going to lose. Now you’re left with $10,000.
Now sadly enough, this is actually a true story. A gentleman just called me a few days ago, from Canada, and he lost 80% of his portfolio in October. Now that’s amazing and the thing is, you know, it’s just—there’s so many courses out there, there’s so many books and there’s so many traders unfortunately, that are just trading credit spreads without any adjustment plan. Their whole plan is based on probability. So they put the trade on and they think you could just leave the trade on without any adjusting and make a living. But the true story is you can lose at 90% on your first trade, even on your second trade or on your third trade. So there’s no guarantee you’re going to make money 9 times and then lose once. That’s the sad truth about this type of trading.
So the bottom line is, we always have to have an adjustment plan. So if you’re doing credit spreads or any other kind of options strategy, make sure you have an adjustment plan. Make sure you’re considering that you might lose the 90% on your first trade if you don’t adjust. What’s going to happen to your account if you’re doing high probability condors and you don’t adjust and you have that bad month, your first month, your second month or your third month. The condor’s another great example that happens if you’re doing 85% probability condors and you don’t have an adjustment plan and you make 10% three times in a row. But then on that 4th month, you lose 85% of your portfolio. You can’t do that.
Main thing I want to say in this class here is always have an adjustment plan. Unfortunately, the credit spreads are a little more difficult. One of the only adjustments is just getting stopped out which is why I don’t like credit spreads myself. But I do use them actually but not by themselves. I use credit spreads as hedges and adjustments for other strategies. I’m not here just to not credit spread traders but I’m just here to say have an adjustment plan and don’t let your portfolio get wiped out in one bad month of the market because it’s happening to people. I’ve been receiving phone calls. Several people have said that they lost 50%, 60%, 70% of their portfolio in October of 2008. Just don’t let that happen to you, learn safer strategies, learn how to adjust your positions, and most of all, learn how to construct safe strategies from the gecko. There’s no reason to put on extremely dangerous credit spreads or just any type of strategy that’s dangerous. There’s no reason to put those on because there’s plenty of other strategies out there that you could construct and have your limited risk from the beginning of the trade.
Finally, I just want to say thank you very much for watching this and to top, I gave you another perspective because I know a lot of people that trade credit spreads, they don’t realize they can have that bad month during their first month or so. A lot of people are thinking 90% means I’m going to make 9 out of 10 times but that’s not true. You might actually have 3 or 4 losing months in a row and then you might have winning months after that. That’s the problem with some of these trades especially if you don’t have an adjustment plan to keep you in the game longer.
Anyway, I just want to say thank you and trade safely and interested in learning some safer strategies, please visit sjoptions dot com (sjoptions.com) and we’ll be glad to help you. You have a great day and once again, thank you very much!