Two days ago I posted my seventh bear call spread in SPY since late August. This time selling the 478/483 spread for roughly $0.80. Now the spread is trading for roughly $0.20. As a result, we can lock in another 13.6% on our spread.
As I stated earlier this week, we’ve had some good fortune since late August using bear call spreads on the major market ETFs. The heightened volatility has allowed us to take on some fairly conservative trades that have thankfully led to some decent profits. And even though I tend to go out 30-60 days with these trades, my average hold time has been just over two weeks.
Implied volatility is now hovering around 27.5% on the VIX and the IV rank for SPY is now reading over 60%. A nice recipe for opening another trade.
Credit spreads are great strategies for this market environment, particularly for those who prefer risk-defined options strategies. Over the past month, I’ve posted six trades using simple credit spreads, bear call spreads to be exact, that have fortunately led to some decent profits.
As I’ve discussed on a few occasions, with a bear call spread I have a decent margin of error just in case the stock, or ETF in today’s example, pushes higher. If it pushes lower, particularly if it is immediate, I should be able to lock in a quick gain.
A few months ago we placed a bear call spread in the SPDR S&P 500 ETF (SPY). Several weeks afterwards we spoke about the potential of locking in 12.4%. Now the spread trades for roughly $0.12 for a profit of 14.9%.
Shortly after that trade we mentioned another bear call spread in IWM. One week later the spread trades for $0.30 for a quick profit of 9.9%. The max potential profit on the high-probability trade is 17.6%.
And following that trade, we placed another trade in the SPDR S&P 500 ETF (SPY). We were able to lock in roughly $0.12, a 17.4% profit.
Just after that trade, we placed another trade in the SPDR S&P 500 ETF (SPY) and closed the trade for roughly $0.30, a 10.0% profit.
On December 22, I placed my final vertical spread trade in 2021. At the time, SPY was trading for roughly 463. After hitting roughly 480, SPY is now trading for 467. Again, this is the beauty of high-probability trading. We are using bear call spreads that are inherently bearish, yet we still have the ability to make money in bullish market environments as well. We sold the 481/486 bear call spread for $0.70 and bought it back for $0.25. As a result, we locked in $0.45 for a 9.9% gain.
Last week I posted another bear call spread in SPY. At the time, SPY was trading for 466.91. Now it is trading for roughly 459.50. As a result, we can lock in approximately $0.60 on the trade for a 13.6% return.
And again, just two days ago I posted another bear call spread in SPY. This time selling the 478/483 spread for roughly $0.80. Now the spread is trading for roughly $0.20. So once again, we can lock in another 13.6% on our spread.
This marks our seventh winning trade in a row using bear call spreads. Again, I’m not trying to hit home runs, simply singles and doubles using a high-probability approach.
Today, I’m going to continue to sell another bear call spread using SPY as my underlying.
With SPY trading for 446.82 I want to place a short-term bear call spread going out 30 days. My intent is to take off the trade well before the February 18, 2022, expiration date. For this bearish spread example, my preference is to go with a trade that has around an 80% to 85% probability of success.
The Trade – Bear Call Spread Example
Let’s start by taking a look at the options chain for SPY with 30 days until expiration. Once we choose our expiration cycle (it will differ in duration depending on outlook and strategy), we begin the process of looking for a call strike within the February 18, 2022, expiration cycle that has around an 80% probability of success.
If you don’t have access to probabilities of success on your trading platform look towards the delta. Without going into too much detail, look for a call strike that has a delta around .20, as seen below.
Since we are focused on using a bear call spread, we only care about the upside risk at the moment.
The 470 call strike, with an 88.56% probability of success, works. It’s just inside the expected range, but we can adjust accordingly if needed. I want to have an opportunity to bring in 15.2%, while keeping my probability of success around 85%.
The short 470 call strike defines my probability of success on the trade. It also helps to define my overall premium, or return, on the trade. Basically, as long as SPY stays below the 470 call strike at the February expiration in 28 days we will make a max profit on the trade. But, as I stated before, my preference is to take off profits early and, in most cases, reestablish a position if warranted.
Also, time decay works in our favor on the trade, so as we get closer and closer to expiration our premium will erode at an accelerated rate. As a result, we should have the opportunity to take the bear call spread off for a nice profit prior to expiration–unless, of course, SPY spikes to the upside over the next 28 days. But still, that doesn’t hide the fact that with this trade, we can be completely wrong in our directional assumption and still make a max profit.
Once I’ve chosen my short call strike, in this case the 470 call, I then proceed to look at the other half of a 3-strike wide, 4-strike wide and 5-strike wide spread to buy.
The spread width of our bear call defines our risk/capital on the trade.
The smaller the width of our bear call spread the less capital required, and vice versa for a wider bear call spread.
When defining your position size, knowing the overall defined risk per trade is essential. Basically, my premium increase as my chosen spread width increases.
Bear Call Spread: February 18, 2022, 470/475 Bear Call Spread or Short Vertical Call Spread
Now that we have chosen our spread, we can execute the trade.
Sell to open SPY February 18, 2022, 470 strike call.
Buy to open SPY February 18, 2022, 475 strike call for a total net credit of roughly $0.66, or $66 per bear call spread.
- Probability of Success: 87.56%
- Total net credit: $0.66, or $66 per bear call spread
- Total risk per spread: $4.34, or $434 per bear call spread
- Max Potential Return: 15.2%
Again, as long as SPY stays below our 470 strike at expiration in 28 days, I have the potential to make a max profit of 15.2% on the trade. In most cases, I will make less, as the prudent move is to buy back the bear call spread prior to expiration. Again, I look to buy back a spread when I can lock in 50% to 75% of the original credit. Since we sold the spread for $0.66, I would look to buy it back when the price of my spread hits roughly $0.33 to roughly $0.16, if not less.
Of course, there are a variety of factors to consider with each trade. And we allow the probabilities and time to expiration lead the way for our decisions. But, taking off risk, or at least half the risk, by locking in profits is never a bad decision and by doing so we can take advantage of other opportunities the market has to offer.
Since we know how much we stand to make and lose prior to order entry we can precisely define our position size on every trade we place. Position size is the most important factor when managing risk, so keeping each trade at a reasonable level (I use 1% to 5% per trade) allows not only the Law of Large Numbers to work in your favor … it also allows you to sleep well at night.
I also tend to set a stop-loss that sits 1 to 2 times my original credit. Since I’m selling the 470/475 bear call spread for $0.66, if my bear call spread reaches approximately $1.32, I will exit the trade.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.