Options trading strategy. Why it's better to trade vertical credit spreads than
naked options. David Jaffee with BestStockStrategy.com, you can visit
BestStockStrategy.com enter in your email address and receive over $400 of
valuable free training in this video we are going to discuss why it's better to
trade vertical credit spreads as opposed to naked options trading spreads is
actually something that is counter to the way that I used to trade up until
about 6 months ago I almost always traded naked options however recently I
have started switching over to trading spreads and the primary reason is that
the increased capital efficiency and the tail risk protection from trading and
selling spreads outweighs the increased amount of premium and the increased ease
that you have when rolling and managing positions so again stated another way I
believe that the capital efficiency and the tail risk protection of turning that
into a defined risk trade outweighs this small decrease in premium that you
receive and also the increased difficulty that you will have when
rolling and managing a defined risk trade relative to a naked option so this
is probably the biggest way that I've actually changed my trading in 2019 I
now primarily trade spreads as opposed to naked options and actually I trade
spreads with virtually every single security so before I used to only trade
spreads with a very expensive security like Amazon or Google just for capital
efficiency purposes but now I believe that trading spreads provides you with a
substantial advantage it is more capital efficient and additionally it provides
you with tail risk protection as an example for the capital efficiency your
broker now again okay let's use 100 shares of stock 100 shares of naked
options and 100 shares of a 4:1 contract of a $5 wide spread if a stock is
trading at a hundred you buy a hundred shares your broker is
going to reduce your buying power by five thousand dollars so you buy a
hundred shares of a hundred dollar stock that is a notional value of ten thousand
dollars therefore based upon regulation T your broker is going to reduce your
available buying power by five thousand dollars if you sell a put with a strike
price of a hundred dollars that allows you to control an option or a hundred
shares of that of the underlying stock at a price of a hundred dollars so it is
for all intents and purposes similar were comparable to buying and going long
a hundred shares of stock your broker is going to reduce your buying power by
twelve to twenty percent it depends upon the calculation but let's just estimate
it and say fifteen percent so remember you're buying a hundred shares of stock
your buying power is going to be reduced by five thousand dollars by selling one
naked put option with a hundred dollars strike your buying power is going to be
reduced by about fifteen hundred dollars if you sold a five dollar wide vertical
credit spread you would sell the hundred strike you would buy the ninety five
strike and let's say you would collect around $1 of premium that means that the
broker would reduce your buying power by only $400 because brokers reduce buying
power with spreads on the maximum loss which would be five hundred dollars per
contract less the credit received so that would be four hundred dollars so
again if you buy all hundred shares of stock your buying power is going to be
reduced by five thousand dollars if you sell a naked put your buying power in
this example is going to be reduced by fifteen hundred dollars if you sold a
vertical credit spread your buying power will be reduced by four hundred dollars
that means that this spreads are about four times more capital efficient than
selling a naked option and in this case they are about 12 times more capital
efficient than stock and you have the incremental benefit of half of turning
it into a defined risk trade and limiting your downside so if the stock
fell to a dollars than the maximum amount of money
that you could lose on a net basis factoring in the premium that you
received for the vertical credit spread would still only be four dollars or four
hundred dollars per contract that you sold this is one of the major changes
that I've made to my trading over the past six months and you can learn more
about it by going to best stock strategy comm slash memberships you can go and
visit best stock strategy com enter in your email address and receive over four
hundred dollars of valuable free training my students consistently make
money in this by trading options you will learn how to be a consistently
profitable options trader leave a comment below and let me know your
thoughts on whether you believe it's better to trade spreads or whether you
still believe it's better to trade naked options the one caveat is that it's very
important for you to not substantially increase your size so even though in
this example that I provided you trading a spread is four times as capital
efficient as trading a naked option that should not permit you to then sell four
times as many spreads as you would have traded naked options so for example if
you were going to trade five naked options if you were going to sell five
naked options you should not go out and sell twenty vertical credit spreads that
is the biggest mistake that I see people who end up losing money by trading
options they just simply trade too big David Jaffee from BestStockStrategy.com
please leave a comment below I respond to everyone's comments and I look
forward to reading your thoughts on whether you believe it's better to trade
spreads or whether you still believe is better to trade naked options