Why Trade Option Spreads?

Option spreads can make money with limited risk within a range of price action, and often within a very wide range, with the market volatility present at this writing.

Contrast this with a directional strategy buying a stock or option and needing it to go up to make money. This can work too, especially in buying quality stocks, over time in a bull market, and definitely has its place.

But there is a certain type of option spread that is a consistent and significant money maker, especially recently with the high volatility.

Why does trading option spreads work?

The major concept, the reason to do the trade, is that options decay in value (often called theta decay and the main theme of this site).

THIS IS IMPORTANT -- The idea is that you sell options when they are worth something, that money goes into your account, and over time the option loses value or goes to zero and you keep the money.

Here's an example of a trade in SPX options, shown as a risk graph (click on the image for a larger view). It is a combination of three diagonal option spreads. This trade has NO RISK to the downside, and the projected breakeven is around 3050 on the upside.

If the market starts to get close to 3050, another spread can be added to push that risk out farther. But this trade can't lose money if the markets tank again.

option spreads

Click the Image to Enlarge

And some detail of the trade: