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Index Credit Spread Trading

Aug 17, 2007
I am an active trader of option credit spreads on the SPX, NDX and RUT broad based stock indexes.

I write OTM Bull Put Spreads first. During months when the market is moving sideways or slightly up, I add OTM Bear Call Spreads to create Iron Condors.

I like trading the Indexes because they are not subject to the same wild price swings as individual stock. It is also easier to make risk management adjustments on Index trades than say GOOG which can change in value quickly on some bad news.

What exactly is a Credit Spread Option Trade? It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the index does not go past the sold strike price at the end of expiration you will receive a full credit winning trade. A profit is realized in a credit spread position if the index moves in the direction anticipated, remains the same and even if under appropriate circumstances the index moves adversely to your position.

What if another event like 9/11 hits the market? Of course no one can predict the future. However it is a good idea to limit your risk and exposure in the market is case an event occurs that causes the market to decline dramatically. All Put Spread Trades should be protected with the Stop Loss orders. These orders are easy to put in place once your spread order is filled. If the market does drop dramatically your stop loss order will be executed automatically by computers and your Put Spread will be closed.

Can I trade credit spreads in my IRA? Yes. The options brokers with allow you to trade credit spreads in your IRA as long as your account is all cash. This is a federal requirement. Also, most brokers will let you use 50% of invested capital in non IRA accounts for margin.

Benefits of Index Credit Spread Trading

1) Index credit spread trades can have a very high probability of expiring worthless when filled.

2) Index credit spread trades can profit in any type of market.

3) The majority of time you make a trade collect your credit and wait for the next month. This is not a day trading system. There is no need to monitor the market and your active trades all day long in front of the computer screen. In fact it's really a very boring trading system.

4) Paper trading is the best way to learn this option strategy. It's all free with CBOE's new Virtual Trading system.

5) The SPX, NDX and RUT Indexes are not subject to the same wild swings as individual stocks.

6) With Iron Condor trades you get double the credit but only have one margin side at risk.

7) You want your credit spread trades to expire worthless but you can always buy them back for way less than you sold them for.

8) Your trading capital is only used to support margin requirements. Most option brokers allow you to invest your trading capital and use it as collateral for spread trading.
About the Author
Brad Griffin is an Accountant and CPA and has been Investing in the U.S Stock Market for 30 years and the options market for the past 5 years. I am now sharing my knowledge and success trading options
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