Credit Spreads: shop around

Major indexes continue to be temporarily directionless. Of course that’s good if you’ve been long theta (profit from time decay, i.e. you sold options).

Economic data continues to be negative; however, none of it is shocking and the market has priced most of this into current prices. It will take another major event to drive this market into the ground, which these days always seem around the corner.

I still feel confident in recommending OTM credit spreads on one of the major index ETFs (SPY, IWM, DIA, QQQQ, etc). Keep in mind that currently you will get better pricing on the downside - due to market bias and volatility skew. If you’re looking for a good probability play, look to sell options with a delta of .07 (although with only 21 DTE (days to expiration) that will be tough). This correlates roughly to options that are 1.5 standard deviations away from the current stock price. You are looking for a 10% return per month with this strategy as well.

In order to get a respectable premium, with only 21 days until April expiration, you might have to sell options with a slightly higher delta. Then buy an equal number of puts x strikes below depending on your risk profile.

For the following example, let’s use options that are 3 points apart. Also, and this is in regards to a previous post, I want to point out the difference in premium between similar index ETFs, when they should seemingly have the same risk/reward profile. Hopefully the following example will make this easier to understand.

Suppose you think that SPY has found support around 125. You could sell SPY puts at 122 and buy SPY puts at 119. The short puts have a delta of .09 and the long puts have a delta of .04. Check out the trade calculator.



OR you could do the same for DIA - sell the 114 puts, buy the 111 puts. The short puts have a delta of .09 (same as SPY) and the long puts have a delta of .04 (same as SPY). Check out the trade calculator.



In my opinion, you’re better off going with SPY, on this day, at this time, all else equal. I know that's a lot of qualifiers but these things aren't static and may be opposite tomorrow. Here's why I think SPY is a better play.

SPY will yield a credit of $290

DIA will yield a credit of $280

First the obvious, SPY yields a credit of $10 more. But there's more: SPY would require a 7.1% move down to hit your short strike, whereas DIA only needs a 6.6% move down to hit your short strike. Granted, SPY and DIA are not the same and do not move identical to one another but I think you'll find them extremely comparable. Keep this tip in mind the next time you are 'shopping' for the best credit spread.