Monday, April 03, 2006

Blog of the Week: Option Investor Blog

Credit Spreads - A conservative approach to Options

This week we are going to look at a Credit Spread, and how you can use it to generate cash flow. The credit spread is an options trading technique that involves the purchase of an option and the sale of an opposing option position for a net credit, and is a powerful option strategy that can be used to gain consistent profits

Introduction to Spread Trading

In option markets there are many ways to trade for profit. The most common strategy involves speculating on the direction in which the underlying security will move. If a trader correctly predicts the market direction and takes the appropriate position he can expect to make a profit. But even when the market moves in the expected direction, owning the correct position (call or put) will not necessarily be profitable. The problem is, while the trader is waiting for the option's price to move towards its theoretical value, the position is at risk from a wide variety of changes in the market which threaten its potential profit. For this reason, the majority of successful derivatives traders engage in spread trading.

A spread is a strategy which involves the buying and selling of simultaneous but opposing positions in different option series. The use of spreads or stock/option combinations is simply a way for traders to take advantage of favorably priced options, while at the same time reducing the effects of short-term changes in the market so that he or she can safely hold an option position to maturity. Spreading techniques basically help to maintain an acceptable level of profit while limiting potential losses and although there is no "perfect" strategy in the options market, successful traders attempt to reduce risk as much as possible in every portfolio position.

Credit Spread Basics

A credit spread is a simple strategy that...


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