OTM verticals to trade direction

[wal]

Hi options traders,

I have this discussion going on another forum... a particular trader is using this strategy (i,e bull put credit spreads) to trade direction... basically swing trading. I have my own thoughts on this, but was wondering what other options traders thought of this.

Cheers

 

[garethb]

I've always viewed this as more of a play on time decay/ stagnation of price at support rather than a real bullish directional play. The nominal risk/reward often looks poor but they can be picked to have a high probability of success. Reward is capped so not a great play if you are expecting a big upside on the underlying where trading the underlying dirrectly or buying a call or debit call spread can be better. I tend to keep them short term to capture time decay into the nearest expiry.

An example on a US stock BVF based on Fridays closing prices. This is not a trade recommendation just a chart I found quickly to provide some real numbers.

If a trader thought BVF was well supported around $22 then he could sell $22.5 Dec put for .65 and buy $20 Dec put for 0.15 for a net credit of 0.50 or £50 per contract. All this is kept if the stock is above $22.5 at expiry in 3 weeks time. Max loss if the stock drops to $20 or less is $200 percontract and that is probably the margin that would be expected by the broker. Breakeven is $22. Not spectacular excitement but time is on your side and you win if the stock does pretty much nothing or rises. Enter the spread on a limit order and could probably get .55 at current levels (reward $55 for risk of £195) or could try to let the stock come down a bit more for the entry.