Vertical spreads are a defined risk trade suitable for smaller accounts and this segment tells you practically everything you need to know to make money using them (not including the direction of the underlying). Even experienced traders can learn something new here. Also watch today's Option Jive which contains even more information on vertical spreads.
Assuming that you already have a bullish or bearish bias in the underlying there are two important decision to be made in establishing a position in a vertical spread. One is to choose the strikes and the other is to choose between a debit spread and a credit spread. A table was displayed of a bullish assumption and a bearish assumption. The table showed the setup of a credit spread and a debit spread for both.
The next table showed a quick and easy way to determine if a spread was bullish or bearish. It’s very easy. Another table showed this for the theoretical XYZ stock.
The segment continues with an explanation of how to choose between a debit and a credit spread. The implied volatility rank is the key and a simple rule is provided.
Choosing the strikes to use is also explained. A few simple calculations are all that is required to estimate our probability of success. The trade-off between the probability of profit and risk are also explained and demonstrated.
Takeaways:
Generally we choose credit spreads when IV Rank is high and debit spreads when IV Rank is low
Higher probabilities of profit can be achieved, but this comes with a lower reward and higher risk
With credit and debit spreads, tastybite traders always have strategies at their disposal, in all volatility environments
Watch this segment of “tasty BITES” with Tom Sosnoff and Tony Battista to learn when to use both credit and debit spreads in different volatility environments and how to choose the strikes.
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