An Alternative to Selling Option Premium

We have talked many times about the draw of selling out-of-the-money (OTM) vertical credit spreads for an option trader. Putting it bluntly, the odds are on your side to make money. But guess what? The risk/reward is not so sweet. If you have looked at implied volatility (IV) levels and option prices recently, you know they have been very low. And some would consider option prices cheap. I’m not trying to talk you out of taking credit spreads. Instead, I’m suggesting you consider vertical debits when there is a directional bias and option prices are low.

When There’s a Directional Bias

I look at it this way: If I am not sure an underlying is going to move higher or lower but believe a level will hold (such as support or resistance), I consider a bear call or bull put. But, as mentioned above, premium is hard to come by in this environment. It may be time to look at buying some bull call and bear put spreads instead. Vertical debits are not a substitute for OTM vertical credits because you generally need the underlying to move higher or lower to profit. But when there is that outlook, option traders will often pass on vertical debits because they are so used to selling credit spreads.

Profitable Vertical Debit Examples

Over the past couple of weeks in MTM’s Group Coaching class, we have modeled out several profitable vertical debits. Just this past week we did a couple of them on BA. We recently bought a Dec-01 222.5/225 bull call spread, and the previous week we did a Nov-24 215/220 bull call as well. A bearish trade on GLD profited in one day after a Nov-24 184.5/185.5 bear put was implemented. A NFLX Nov-17 455/465 bull call did extremely well. There were several more too. For all these trade ideas, bear calls and bear puts could have been considered as well. But with a directional bias and eventual follow-through of the underlying, a bigger profit was attained.

Change Your Thoughts

Practically everything in options trading is a risk/reward and a probability trade-off, including verticals. This is just a reminder to consider vertical debits at times, especially when IV levels are low.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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