As a great options trader once told me - professional options
traders are a different breed. We take a statistical, mathematical,
rational approach to the marketplace. We add another layer of
probability and risk management that is not possible with stocks
We make investments on things like volatility and don't always care
which way a stock or ETF moves. Everything we do is at least
partially hedged, which reduces the need for Maalox, Prozac and
heavy drinking, which many of my stock-trading buddies rely on
Fear is certainly in the market. Look no further than the
Volatility Index, or the VIX (otherwise known as the investor's
fear gauge) to see that the fear is palpable. However,
opportunities are plentiful with the VIX trading at 35 - especially
those of us who use credit spreads for income.
In short, a credit spread is a type of options trade that creates
income by selling options.
And in this type of atmosphere, fear makes the volatility index
rise. . And, with increased volatility brings higher options
premium. And higher options premium, means that options traders who
sell options can bring in more income on a monthly basis.
So, I'm selling credit spreads. And I'm make more money than I was
say, just a few weeks ago, when the VIX was half what it is today.
Over the past month or so I have explained
how I use credit spreads
bring in income on a monthly basis
Now I want to tell you about another trade that I am eyeing as we
enter the week.
As we all know the market fell sharply last week and now the small
iShares Russell 2000 (
is roughly 18 percent below its high a month ago.
So how can credit spreads allow me to take advantage of a market,
and specifically an ETF, that has declined this sharply over the
past few weeks?
Well, knowing that the volatility has increased dramatically over
the past few weeks causing options premiums to go up, I should be
able to create a trade that allows me to have the same profit range
of 10-15 percent while creating larger buffer than normal to be
Sure, I could swing for the fences and go for an even bigger
pay-day, but I prefer to use volatility to increase my margin of
safety instead of my income.
Basically, IWM can move 9.8 percent higher and the trade would
still be profitable. This margin is the true power of options
So, let's take a look at a potential trade using IWM, which is
currently trading at $70.86:
- Sell IWM Sep11 78 call
- Buy IWM Sep11 80 call for a total net credit of $0.24
Again, the trade allows IWM to move lower, sideways or even 9.8
percent higher over the next 32 days (September 16 is options
expiration). As long as IWM closes below $78 at or before options
expiration the trade will make approximately 12.0 percent.
It's a great strategy, because a highly liquid and large ETF like
IWM almost never makes big moves and even if it does, increased
volatility allows me to create a larger than normal cushion just in
case I am wrong about the direction of the trade. So, selling and
buying these two calls essentially gives you a high probability of
success - because you're betting that IWM will not rise over 10
percent over the next 32 days.
Again, my space is limited here so I will go into greater detail
next week. The questions have been rolling in and please keep them
coming . Email me at
Click here to
read more articles from the
Small Cap Investor Daily