Is the Debit Spread Options Strategy “THE KEY” to Success?
The debit spread is an options strategy that certainly deserves some love. Maybe I’m still green at heart or maybe just maybe I really prefer risking $20 to make $200, $300, or even more. The truth however, for this options strategy, lies with probability. As it does for every options strategy. Common sense should tell you that risking only $20 to make $300, probability…ily speaking, the odds of success are quite low.
But… this forces us to have a conversation about what qualifies as a “success”. Does success occur only when we turn that $20 into $300 or can it occur at some other level?
Some may view turning $20 into $40 as a success, this is after all a 100% Return on Investment (ROI). Still, others wouldn’t take the trade without larger aspirations.
No matter what level you believe is a successful one make sure its determined before you place the trade. Period. Live with the decision once the trade is live. If it takes a while to be filled or you wish to wait before submitting then feel free to change your profit target as needed.
Bringing me to my last point…
If a profit target is critical to trading success then it should be apparent that a loss target is, at least, equally important. Nope, its the MOST IMPORTANT!
In my hypothetical $20 example above a trader may be willing to go all or nothing, but lets pretend for a minute that you were trading 50 lots (50 spreads). Your desire to let $1k “just ride” may be slightly different. Therefore, if you’re trying to be successful in this business for any length of time, NEVER just let it ride! Set a stop loss target and adhere strictly to it. I don’t care if you lose money, you’re going to lose money sometimes.
Lets take a look a few spread examples and their respective charts.
Nike (NKE) Technical Analysis
I want to draw attention to a few key points from this chart;
1. Nike is breaking out of a resistance area
2. Nike has increased and is increasing in volume (both are meaningful)
3. TA indicating a move higher (at least, in near term)
With this information, NIKE is a strong candidate to continue higher, at least in the near term. If you disagree with my assessment of NIKE that’s ok. There could always be an argument the price is ready to retrace.
No matter which direction you choose, if you’re playing the debit spread options strategy you’ll have to pick one or the other. Before moving on, take a look at my debit call and debit put spread pages. These will give you a good list of criteria for selecting quality debit spreads.
In any case, the two biggest secrets to trading successful debit spreads are; low volatility and time. So, for the love of trading don’t buy debit spreads on near term expiration options. Unless you have a fool proof way to determine price direction I strongly suggest against them for many reasons.
Two Secrets to a Profitable Debit Spread Options Strategy:
1. Find low volatility ready to expand
2. Allow enough time to be right
Now, lets look at the options chain and see which strike would make sense.
Nike’s March option chain.
Contracts in this chain expire in 36 days, also referred to as 36 DTE.
As you can see in the first image of NIKE’s chart, price closed at $55.31. Ideally, I’d want to route my trade prior to the closing bell or at any favorable intraday pullback.
To do this, simply bring up the 1 min., 5 min., 15 min., or hourly chart. That said however, its the story from the daily chart is the most important when trading options with a relatively short time horizon.
Nike 1 minute chart.
Identifying entry and exit
Highlighted above would have been just about the best entry possibilities for this trade, but don’t spend a great deal of time at this stage. Spending to much time waiting for a perfect entry could cost us the larger upside move. Sometimes you just have to go for it.
With the underlying entry price area determined lets turn our attention to the several trades that could be deployed.
Example Nike debit spreads
As you can see, each trade turned profitable immediately. This isn’t always the case so if it hits your stop don’t do the same thing you’ve done 100 times before and rationalize with yourself about why the trade will come back. Just let it go (trust me, this is the hardest part of trading).
The advantage of the $57.5/$60 spread for $.265 is its cheap. Meaning, multiple lots can be deployed for a modest level of risk. The harm here is with only $26.50 in premium per spread one adverse move could cripple the trade for good.
The trade I would prefer rests in the middle. The $55/$57.5 spread for $.935. Being right ATM the spread will bounce in and out of the money through the life of the spread. Should price not move favorably, it may still be possible to profit simply from a volatility increase.
The third trade is the only trade I absolutely wouldn’t take.
Its just far to expensive and it puts too much capital at risk. There is a better delta position but I don’t see the increased risk being a fair tradeoff.
As a final note before I close. Please remember that each spread has a maximum reward of the difference between the debit paid and the strike width. For example; the $57.5/$60 spread above has a total debit of $.265 and a strike width of $2.50, making the reward to risk on that trade undeniably attractive.
$2.50 – $.265 = $2.235 total reward
In percentage terms and assuming max profit, it makes the trade 843% attractive. Further suggesting the debit spread as THE trade to consider, for any level trader.
