Live Option Trade Case Study: 4 – Average Winning Credit Spread

Yet another credit spread live option trade example/case study. This trade was another profitable trade. Nevertheless, it didn’t go down as perfect as the last presented trades did. I will add some losing trades next to give a little more diversity (even though most of my trades are profitable up until this point). This trade breakdown will probably be one of a relatively average trade that didn’t turn profitable instantly but didn’t lose either. This should give you a good impression of a standard credit spread.

Before I start with the actual trade, I wanted to say that all the trade examples including this one were performed inside of the broker platform Tastyworks in a small account.

You can read my full Tastyworks Review here!

General:

As always, let us start with the underlying asset and the reason for why I chose it. This credit spread was on the same underlying security as my first trade example. The underlying that I chose was the iShares Russell 2000 ETF (ticker symbol: IWM). This is a very liquid and good underlying. To learn a little more about it, read my first live trade example HERE. Implied volatility (IV) wasn’t too high, but nevertheless, I made this trade. IV Rank was ca. 30.

Strategy:

Just like I mentioned before, I went for another credit spread as a strategy. Credit spreads are an amazing strategy that are suitable for almost everything. Therefore, you can almost never go wrong with a credit spread. In addition to that, all these live trades are performed in a small trading account in which I want to show everyone that you can start trading with very little capital. Therefore, I don’t want to do too many directional bets/low probability strategies, because these are better for diversification which I don’t really need in a very small account. I chose to do a bearish call credit spread mainly because the call options once again had better pricing than the put options. I did not really use any technical indicators and signals to make my mind up.

Strategy Setup:

At the time of entry, IWM was trading for around 137$. The specific strike prices that I chose for my bear call credit spread were:

• Short 139.5 Call
• Long 140 Call

Similar to previous examples, I went for two a few strikes OTM call options so that the price of the underlying (IWM) still has some room to move. Additionally, this improves the probability of profit (POP). The probability of profit was just around 65%. You may have noticed by now that many of my credit spreads are just around this 65% POP mark. This is because I find that this is the range where options often have the best pricing and it seems most worth it. I don’t want to give up too much premium for a few percent higher success rate. My max loss on this trade was 32$ and my maximum achievable win was 18$. To identify ‘good’ pricing I do this short calculation:

POP x Max Profit – (100-POP) x Max Loss

If this calculation is greater than zero, the price is good enough for me. Otherwise, I either adjust the price or don’t make the trade. This was the calculation for this credit spread:

65 x 18 – 35 x 32 = 50

As this is not below zero, I consider this good pricing. I chose the option contracts with about 28 days left until expiration (September 8th). This was on the one side because they had the best pricing and because I didn’t want to do a too short range trade. 25-35 days to expiration are in my opinion optimal. This isn’t too much time but isn’t too little time either.

After I was filled, I sent out a GTC (Good Til Cancel) order at my profit target. GTC order run until they either are canceled or filled. My profit target was right around 55% of the max achievable profit. As long as the price of IWM would stay below 139.5$, this spread would reach max profit. Time decay or the option Greek Theta also worked in favor of this position meaning that the more time passes, the more profitable the credit spread will be. In total, I only went with two contracts per call option. This is because of this small trading account. I never really allocate more than 5% of my total account balance to one position no matter the size of the account.

I entered the credit spread while its underlying price was falling. The price fall continued after the entry for about another day or so. This led to a small profit on paper in this position but as there still was so much time left on the contracts the profit was rather minor. After that day IWM’s price began to rally again. This continued for another few days. On paper, the credit spread was in the red during that time. But this does not mean that the credit spread was losing. If everything would have stayed like that and only time would have past the credit spread would still have been profitable. The only reason for the paper loss was that there still was a lot of time left in the options extrinsic value that had to decay. After those up-days in the underlying, its price began to fall again. The fall was interrupted by a short pullback and then continued to fall even more than it did before. After ca. 11 days, the credit spread was finally closed because the GTC order was filled at my profit target. The profit was 11$ (per contract).

On the chart below I marked the entry and exit point with two red circles. In addition to that, I marked the breakeven point with a blue line. As clearly recognizable, the price of the underlying did never surpass this point even though it was ‘losing’ on paper.

Conclusion:

First of all, I want to say that this is another great example of a trade that could have been done in any account regardless of size. This trade and my small Tastyworks example account in general really show that trading does not have to require tons of capital. You really don’t need much more than 1-2 thousand Dollars to start with.

Otherwise, I would say that this is an example of a fairly average option credit spread. It was closed for a profit but it had a loss on paper before. People that want to trade credit spread do have to understand this. Credit spreads aren’t meant to be winning instantly. They profit from time decay. So don’t freak out when your credit spread shows a loss sometime before expiration. It is much more important to look at the underlying price compared to the strike prices of the credit spread. A credit spread is first then losing when the underlying price has surpassed the short-long strike price of the spread. Beware of the breakeven point. But even if the price of the underlying surpasses the strike price, I would still recommend to hold on to it (if there is enough time left until expiration). Credit spreads are a defined/limited risk option strategy. As long as you don’t have too big position sizing, you can’t lose too much on one spread.

Furthermore, you really can see that trading does not have to take up a lot of time. This trade probably took around 5-10 minutes at most. All I did was set it up, order and send out a GTC order after the fill. Then I only had to play the waiting game and that was it. You can easily trade like this even with a full-time job or other occupation.

If you want to learn more about my trading style and options, you can check out my free education under the ‘Options Trading Education’ in the menu bar at the top!