During the past few months, we have been following a mock trade using a credit spread strategy. The stock we chose to use was Activision (ATVI), but with option expiration this Friday, this will be our last update on this trade. As you can see from the data below, ATVI is trading well below $20, which is our max breakeven point. This means that the best thing to do would be to let the options expire. This allows us to keep the credit without the need to pay commissions to close the trade.

Below is the week-to-week data for our bear call credit spread:

11/12/02
ATVI Bear Call Spread
ATVI @ 19.97
Buy 10 Dec 22.50 Calls @ 1.00
Sell 10 Dec 20 Calls @ 2.00
Net Credit = 1.00 or $1,000
Max Risk = $1,500
Breakeven = $21

11/19/02
ATVI Bear Call Spread
ATVI @ 18.77
10 Dec 22.50 Calls @ 0.35 (bid)
10 Dec 20 Calls @ 1.20 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.15 or $150
Max Risk = $1,500
Breakeven = $21

11/26/02
ATVI Bear Call Spread
ATVI @ 20.39
10 Dec 22.50 Calls @ 0.55 (bid)
10 Dec 20 Calls @ 1.55 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.00 or $0
Max Risk = $1,500
Breakeven = $21

12/03/02
ATVI Bear Call Spread
ATVI @ 20.90
10 Dec 22.50 Calls @ 0.50 (bid)
10 Dec 20 Calls @ 1.70 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.20 or $200
Max Risk = $1,500
Breakeven = $21

12/10/02
ATVI Bear Call Spread
ATVI @ 18.12
10 Dec 22.50 Calls @ 0.00 (bid)
10 Dec 20 Calls @ 0.35 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.65 or $650
Max Risk = $1,500
Breakeven = $21

12/17/02
ATVI Bear Call Spread
ATVI @ 15.73
10 Dec 22.50 Calls @ 0.00 (bid)
10 Dec 20 Calls @ 0.15 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.85 or $850
Max Risk = $1,500
Breakeven = $21

Let’s discuss again the theory behind a credit spread and how to find good candidates for this strategy. A credit spread is the simultaneous sale and purchase of options with the same expiration month, but different strikes. For a bear call spread, we sell the lower strike call and buy the higher. For a bull put spread, we sell the higher strike put and buy the lower. This type of strategy is beneficial when we expect a sideways to moderate move in the stock. Ultimately, it would be nice to sell high IV, as a drop in IV could give us a quicker profit. However, the key is that we do not see the stock moving ITM before option expiration. The advantage to a credit spread is that we have a 67% chance of success. This is because a stock can move down, up or sideways and with a credit spread we profit from two of these options.

There are various ways to find credit spread strategies, but a common way is to scan charts to find stocks approaching resistance or support. If a stock has strong resistance to overcome, then placing a bear call spread might be a profitable choice. For a stock hitting strong support, we would want to check on entering a bull put spread. At times, we may even think about entering a bull put and bear call spread on the same stock. Of course, this would only be advisable if we feel the stock is going to stay in a range. Credit spreads should be entered using options that expire in 45 days or less. This is because we benefit from the passage of time and the last 45 days of an option’s life is when it sees the largest time decay.

As with any strategy, a credit spread has its place and its risks. Often, the max risk will be more than the max profit, but this is because the odds of a profit are normally pretty high. Nonetheless, we should understand the risks before entering and should set an exit price at the point where we no longer are willing to accept the risk. Please feel free to ask questions and give ideas for our next Real-World Trading strategy on my forum.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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