Worried How Your Credit Spread Will Fare if the Market Reverses?

Article Written By: Johnny M Junior

When used alone, credit spreads are very directional and embed a lot of risk into a trade. I'm not a big fan of credit spreads. While credit spreads have a high probability mathematically, they are also usually stressful as they are very risky. However, even though this type of trade is high risk, many option traders in the world continue to use them. So in this article I want to explain a simple adjustment you can apply to this strategy in order to lock in profits when it does, in fact, work out as planned.

As an example, imagine you enter into a credit spread and the market goes in the right direction quickly. Right away your trade is up 5%. You might be tempted to exit this trade at this point, to capture the profit. This seems reasonable. There's a simple adjustment, however, that you can use to lock in your profits and then continue to stay in the trade even longer. All you need to do is add a debit spread to the existing trade in order to neutralize the Delta and lock in profits on your credit spread. This will give you the chance to make money should the underlying asset suddenly move sharply in the opposite direction.

Since the market nowadays often moves up and down, and up and down again so frequently, this simple adjustment strategy can work quite well. This is one of my favorite adjustment strategies for capturing profit on credit spreads for two reasons. One, it's very simple and straightforward and two, you can make even more profit when the market unexpectedly reverses.

This adjustment is very easy to do. For example, if you are trading the RUT and your credit spread is a bull put spread at strikes 700 and 730. Once a profit is realized, you might consider buying a 760 and selling additional 730 contracts. Technically, this would end up being an unbalanced butterfly if the number of debit spreads does not equal the number of credit spreads.

This easy adjustment will usually give you a chance to lock in profits and continue the trade. Let me repeat that credit spreads are not my favorite type of trade, but if you like them, then it'll be worth your while to employ a couple of techniques that will lock in your profits. I hope you find these suggestions helpful. If you run with them and expand on this approach, you may well develop some powerfully effective adjustment strategies as an options trader.

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Trade options, not your livelihood. Learn safer ways to Trade Options with San Jose Options. Visit now for your free Video!

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