Make money with credit spreads and options: here’s how

If you are bullish on any option stock in any stock sector, you can play any number of options trades. The simplest directional strategy is to buy a call option. However, you will be fighting against time whenever you hold a long call option as Theta (time decay) works against you. Even if the underlying stock remains stable, the option loses money incrementally every day based on the Theta value. You also have the possibility of losing 100% of your investment if the stock closes below the strike price at expiration.

Naked sales strategy

You may want to consider a naked put strategy, also known as selling or shorting a put. While this bullish directional trade can reap upside profits and is Theta-friendly as you gain on time decay, the risk of being assigned if the stock closes below the strike price can be costly. Unless you want to own the shares at the selected strike price. Additionally, most brokers require a higher options clearance to qualify for naked put trading.

Call Debt Spread Strategy

Consider a call debit spread strategy where you simultaneously buy a call option and sell/short a higher strike price call option. It’s called a debit spread because you pay the difference in premium between the prices of long and short call options. This allows you to pay less for the long directional position than simply buying the calls. However, your upside is limited to the highest strike price of the short call option. In exchange, your downside is also limited to the cost of the spread, which is still less than the 100% loss of the long call option. Theta is not your friend on debt spreads. Debt spreads are preferred when implied volatility (IV) is low.

Put the credit spread strategy

Another option strategy is called a put credit spread, also known as a bull put credit spread or short put spread. This is similar to the debt spread strategy but with some variations. In this trade, you would simultaneously sell a put at a strike price that you believe is a support level and simultaneously buy a put at a lower strike price. It’s called a credit spread because it pays you the premium first, meaning you get credit up front.

The maximum profit is the credit premium you receive. You retain the net credit premium if the stock remains above the highest strike price at expiration.

Theta is your friend on put credit spreads because when you sell puts, you are the one collecting on time decay. Credit spreads are favorable when implied volatility (IV) is high. The maximum loss is reached if the underlying shares fall below the lower level of the long put’s strike price. Your loss would be the difference between the put strike prices minus the premium received. The advantage of a credit spread is that you get paid your maximum gain upfront versus a debit spread where you pay your maximum loss upfront to capture the spread.

Put on the market

Let’s use Intel Co. NASDAQ: INTC on the daily candlestick chart.

INTC trades at $42.85 on February 27, 2024. The $45.28 level was a resistance level to fill the gap as it lagged the Q4 2023 earnings miss and lowered guidance. There are two relatively strong support levels at $41.38 and $39.00. The daily relative strength index (RSI) is starting to lose momentum again as it slips towards the 40 band. If we feel bullish on the INTC, then we can consider a put credit spread around the support levels to reap the rewards.

The put credit spread is a vertical options trade consisting of selling/shorting a $41 put and buying a $39 put option, both expiring on March 28, 2024, 30 days from now. Many brokerage platforms already have credit spreads available, so you can place a single trade instead of manually entering 2. The cost of the INTC $41/$39 put credit spread is 47 cents or a $47 credit given to us. There is a 73% chance of a profit.

Both strike prices represent price support levels for INTC. The spread is $2 between strike prices. Since we are bullish on INTC, we expect INTC to trade above the $41 price level support at expiration in 30 days on March 28, 2024.

Possible results

Upon expiry, if INTC closes at $41.00 or higher, so we maintain the premium of 47 cents x 100 shares for a profit of $47. The $41 represents the highest strike price. There is a 70% chance of a profit. This is a maximum risk return of 30.7%.

If INTC closes at $40.53, the trade is breakeven.

IF INTC closed below $39.00, we would lose the difference between the $2.00 strikes minus the 47 cent premium received for a maximum loss of $1.53 or $153.00. The $39 represents the lowest put strike price.

Manage the trade

As with all options trades, you do not need to hold them until expiration. At any time you can make changes or close the position. Since this is a credit spread, the position profits daily from time decay. The trade is profitable if INTC trades between $40.54 or higher with a maximum profit above $41.00. The trade loses money when INTC trades below $40.53, with a maximum loss triggering below $39.00. We will cover ways to mitigate losses in future options articles.

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