Vertical credit spreads are a popular option strategy for a reason. They give an option trader a high probability of a profit, especially when the spread is initialized out-of-the-money (OTM). Who does not like a nice probability on an option trade? I always say you have 3 out of 4 ways to make money. The only way to lose is when the underlying moves against you in a way that was more than intended. That said, there may be one time in particular when it is not optimal to initialize a vertical credit spread. Let’s take a look.
Selling a bull put (vertical put spread) when the underlying is at a potential resistance level may not be optimal. At resistance, the underlying has a better chance of not moving higher and actually reversing and moving lower. Support and resistance have a better chance to hold and reverse. When an option trader sells a bull put, he or she prefers the underlying to move higher, although a profit can still be realized if the underlying does not move too much lower.
In the following example, there is potential horizontal support below, but the underlying is trading up at a potential horizontal resistance level above the potential support currently. It has a better chance to now move lower than higher.
In addition, since the underlying is closer to a potential resistance level than the potential support level below where the put spread may be initiated, the premium received will also be smaller than if the underlying were lower and maybe closer to potential support.
Selling a bear call (vertical call spread) when the underlying is at a potential support level may also not be ideal. At support, the underlying has a better chance of not moving lower and actually reversing and moving higher. When an option trader sells a bear call, he or she prefers the underlying to move lower, although a profit can still be realized if the underlying does not move too much higher.
In the following example, there is potential resistance from the 50-day moving average (blue line) below, but the underlying is trading down at a potential horizontal support level below the moving average currently. It has a better chance to now move higher than lower.
In addition, since the underlying is closer to a potential support level than the potential resistance level above where the call spread may be initiated, the premium received will be smaller than if the underlying were higher and maybe closer to potential resistance.
Timing Is Everything
Timing is important in many different aspects of life, not just trading. But if you like to sell credit spreads, just being cognizant of when you execute your spread can make a big difference.
Senior Options Instructor
Market Taker Mentoring