Selling Options can be a profitable trading strategy if used properly. I especially enjoy using spreads as a way to sell options without using as much capital and defining my max risk. In this article, I will discuss my process that I use to sell spreads on the Robinhood platform.
What is a Put Credit Spread?
A Put Credit Spread is selling a cash-secured put along with also purchasing a long put. An example would be:
Selling a $400 PUT on Stock XYZ.
Purchasing a $395 PUT on the same stock – Stock XYZ.
I would receive a net credit.
Let’s say the $400 Put was giving a credit of $100 in Premium for selling it.
And the cost to purchase the $395 Put was $50.
So our net credit would be $50.
And our max loss would be the width of our strikes – $400 – $395 – $5 * 100 – $500.
Minus the credit, we received – $50.
$500 – $50 = $450 Max Risk for this Position.
What Is Our Risk / Reward for this type of Trade?
So our risk to reward would be risking $450 to make $50 or an 11.1% return on risk.
Additional Things To Consider
Early Assignment Risk – if the underlying Stock or ETF has an upcoming ex-dividend date this is important to remember because the option buyer may exercise your short option early in order to receive their dividend.
Stock / ETF closing in between your strike – this is the worst-case scenario & can result in a very bad position to be in. If for example you sold the $400/$395 spread and the stock/etf finished in between those strikes – the option buyer would be able to exercise their $400 option but since your $395 option is out of the money – you couldn’t exercise yours, so your defined risk would be off the table.
So – be sure to ALWAYS CLOSE YOUR SPREADS BEFORE EXPIRATION or roll them out further in time.
It is not worth the risk of holding them – for a situation like this to happen to you. Sometimes your broker (Robinhood, Td, etc) will close them out for you if they view it as close enough to be risky, but sometimes they won’t. So, be responsible, smart & understand that this can happen if you don’t close before expiration.
Disclaimer – Use this for Educational Purposes Only
We are not financial advisors – so be sure to understand all of your risks before selling/buying options. We’ve done our best to explain these types of trades to the best of our abilities but we are not reginstered financial advisors, so do your own research before ever trading in the stock market.
Robinhood – Sign Up Bonus
Robinhood is currently offering a signup bonus – When you signup through this link you will receive a one-time stock bonus valued between $5-$200 dollars. Robinhood has had it’s ups & downs over the years – but I still enjoy using it because of its user interface & its commission-free option structure.