Alright, here’s the second way to use options to make weekly options profits, and at the same time put the principal of “Time Decay” on our side.

This is my number 1 way to make weekly income.

All the VIP picks are based on this strategy.

This is a great options strategy because it puts you in the same position as my friend on the floor of the option’s exchange only with less risk.

Another great thing about this is that the price of the underlying stock does not matter.

This is great for the little guy who wants in on the action of high priced stocks in great trends.

It involves selling a PUT and buying a PUT.

Selling Put options can also be very risky so, as a way to “hedge our risk,” we purchase a lower strike priced Put option for protection.

This way, if we get the stock “put” to us, we can turn around and “put” it to someone else at a lower strike price… if we want. This is called a Credit Spread.

To be more specific, this is a “Bull Put Spread.”

What we’re doing, when we execute a Credit Spread, is sell an option to bring in money, then buy another option… as a hedge to reduce our risk and give an opportunity to make even more if the trade goes bad.   One great thing about this strategy is that the price of the stock doesn’t matter. Your only capital requirement is the difference between strike prices.

The Bull Put Spread Defined

Bull – because we use it on stocks in bullish patterns and stocks we think will rise or stay the same in price.

Put – because we use Puts to create the income.

Spread – because we sell one Put and buy the next lowest strike price Put to create the credit.

The Bull Put Spread is a Credit Spread.

Credit Spreads create positive cash flow into your account.

You will receive a credit when you do a Credit Spread. Debit spreads require you to pay to do the spread.

A Credit Spread is a stock option’s trading strategy that allows option’s traders to have time decay work in their favor and hedge their risk.   To create a Bull Put Credit Spread, you would simultaneously sell a Put option and buy a Put option that expire at the same time but have different strike prices.

The Put you sell is closer to the money than the Put you buy and therefore has a higher premium.

The price of the Put you sell is greater than the price of the Put you buy. You receive more money for the Put you sell than you pay for the Put you buy. You will receive a net credit in your account. That’s why it’s called a Credit Spread.

The objective is for both the Put you sell and the Put you buy to expire worthless so you can keep all of the net credit.

What EXACTLY Is Happening When You Execute A Bull Put Spread?

Exactly what is happening is this…

You sell a Put and receive money for doing it. What you’ve done when you sell a Put is, you’ve sold someone the right to “PUT” the stock to you at the strike price of the Put you’ve sold.

At the same time, you buy a Put at the next lower strike price.

What you’ve done when you buy a Put at the next lower strike price is you bought the right to “put” the same stock to someone else 5 points lower than someone can “put” it to you.   When you buy the next lower strike price Put, you’ve limited your risk to the difference in strike prices times the number of option contracts.

You receive more for the Put you sold than you spend on the Put you buy and that creates a net credit in your account. The beautiful thing about the Bull Put Spread, is that you get to pick the strike prices.   Say a stock is trading at 80 per share and you’ve identified a support level on the stock at around 70. You can sell someone the right to put the stock to you at 65 and buy the right to put it to someone else at 60. Odds are the stock won’t drop 15 points and you get to keep all the credit you created when you sold the 65 strike priced Put and bought the 60 strike priced Put.   Let’s take XYZ for instance. Say XYZ is trading at 160. For the sake of example, we’ll say you’ve identified support at 145. You could sell the right to put the stock to you at 140 at anytime in the next 7 trading days and receive cash for doing it and at the same time reduce your risk by buying the right to “put” it to someone else at 135 at anytime in the next 7 trading days. You spend less for the Put you buy than you received for the Put you sold and those two transactions create a net credit.   The Bull Put Spread strategy, as I use it, is to sell a deep out of the money Put on a strong stock in a rising trend and simultaneously buy the next lower strike price Put. Then I hold both options until they expire worthless. Both options WILL expire worthless as long as the stock stays above the higher strike priced Put.   The key is selecting the right stocks – stocks that won’t drop down to the level of support.

Why Buy The Lower Strike Priced Put? Why Not Just Sell The Put Naked and Leave It At That?

That’s a naked Put and it’s a good strategy, but it has two major disadvantages to the Bull Put Spread.   First of all the capital required to sell a naked Put is higher than the capital required for the Bull Put Spread. Check it out…When you sell a Put naked, you are required to have at least 25% of the underlying stock in the form of cash in your account. On a stock that trades at $200 per share, if you were to sell Puts naked, you would need to have to $50,000 cash in your account just to be able to sell 10 Put contracts naked.   With the Bull Put Spread, the capital required is only the difference in strike prices times the number of contracts. With our Bull Put Spread strategy, the capital required is only the difference in strike prices.   The second major disadvantage to naked Puts is that your downside is much greater. Theoretically, the stock could go to zero and you would have the stock put to you at whatever the strike price was on the Put you sold.   With the Bull Put Spread, the most you can lose is the difference between the two strike prices, minus the amount you received in net credit.   Buying the lower strike price Put lowers and limits our risk. In the eyes of brokerage firms, Bull Put Spreads are less risky than naked Puts as well.

How You Lose $ In A Credit Spread…   You will lose money any time you unwind the trade and the difference in price between the options you’ve spread widens more than what you’ve received as a net credit.   If you executed a Bull Put Spread and received a .50 credit and then the spread widens to 1.00, you would lose .50 unwinding the spread – that is, buying back the Put you sold and selling the Put you bought.   You will lose your net requirement if the stock drops below your lower strike price Put. This is why it’s important to find stocks that won’t drop below support. The stronger the trend, the less likely a stock is to drop below support.   Actually we don’t even have to identify stocks that will rise, we really are just looking for stocks that won’t drop below a certain level.

When To Bail Out…   My general rule of thumb is that I’m on red alert anytime the stock starts to drop more than a few dollars per share. At that point it’s time to look at what is happening with the options. If you think the stock’s trend is broken and it will continue to drop then you will want to unwind the trade. If you think the drop in price is temporary and it will rebound and close above your higher strike priced put by Friday’s close, then you’ll want to hang on. has dropped to within two dollars per share of my higher strike priced Put.

Technically, your break even point is the higher strike priced Put – the net credit.

So if your higher strike priced Put was sold at $3.00 and your net credit from the spread was 1/2, then your break even point would be the higher strike price minus 2 1/2.

Even though that is the technical definition of your Break Even Price, the reality is that the options will move with the stock and could be volatile enough to make a losing position even though the stock’s price is higher than your BEP. This is why you want to watch it in real-time.

For a more detailed explanation click here 

How You Profit In A Bull Put Credit Spread…   You make money in a Bull Put Credit Spread when the stock closes at a price higher than the highest strike price in your spread on the Friday the weekly option expires.   You want the options to expire worthless. We want to let time decay work for us and erode the price of the option.

When they expire worthless, you don’t have to do anything in your account.

They’ll die on Friday and your available cash will increase by the amount of the net credit.

How To Calculate Your Profit…

You also make money in a Credit Spread anytime the spread shrinks to a difference less than you received in net credit. Anytime you can find a stock that is in a positive trend and the strike prices that yield a credit are far below the current price and you think the stock will not drop down to the higher strike price, you have the possibility for a winning Credit Spread.

Capital Required…

The investment required is really just a cash collateral requirement since the spread is a Credit Spread. You don’t spend money to bring in the net credit but the brokerage firm requires that you have cash on hand to cover the worst case scenario – which is the underlying stock dropping to a price that is lower than the strike price of the Put you bought.

This is the formula for calculating the capital required…

Difference in strike prices x number of contracts.

For a 5 contract spread on strike prices 5 points apart you would need: 5 contracts (each equal to 100 shares) x 5 points difference in strike prices = $2,500 initial capital requirement.

For a 10 contract spread on strike prices 5 points apart you would need: 10 contracts (each equal to 100 shares) x 5 points difference in strikes = $5,000 initial capital requirement.

For a 20 contract spread on strike prices 5 points apart you would need: 20 contracts x 5 points difference in strikes = $10,000 initial capital requirement.

The initial capital requirement must come from the available CASH in your account.

You cannot meet the initial capital requirement with the buying power in your account.

Risks Of The Bull Put Spread…
Maximum potential risk is = initial capital required = difference in strike prices – net credit.
Maximum potential profit = net credit
Break even price = higher strike price – net credit

Benefits Of The Bull Put Spread…
Easily executed – this is a simple strategy that can be executed in one phone call to your broker.
Takes very little time – once you understand the strategy, you can execute it easily in a matter of minutes.
Can be done every week – this strategy can be repeated every week, often on the same stocks.
Easily managed – the ability to check quotes and call your broker if you need to is all that’s needed to manage this trade.

Basically speaking, you lose money in a Credit Spread anytime the spread between the Puts widens by more than you received in net credit.

If you receive a net credit of 1/2 point then the stock drops and the spread between the Puts widens by more than 1/2 point, you are
losing the difference between the current spread and the credit you received.

You will lose your entire net requirement if the stock drops below your lower strike priced Put. In our case, ABCD was trading at 93 and if it dropped below 80 we would have lost all of our net requirement.

Remember, to “unwind” a spread – you simply “buy to close” the higher strike priced Put you originally sold. And simultaneously “sell to close” the lower strike priced Put you originally bought. “Buy to close” and “sell to close” means buying or selling to close out the position. When you initiated the trade, your order was entered as “buy to open” the lower strike priced Put and “sell to open” the higher strike price Put. Buy to open and sell to open refers to opening the position.

An alternative to unwinding the spread is simply “buying to close” the higher strike priced Put you sold. Buying this Put back will eliminate any obligations to the trade.

How To Reduce Risk…

There are three major keys to reducing your risk with this strategy.

1. 1. 1. First of all, stick with strong stocks, rising trends and identifiable support as indicated by the EMA’s. Make sure the stock has no violations of breaking support of the intermediate term EMA.
      2. Second of all, stay deep out of the money on your spreads. The deeper you go, the less risk you have.
      3. Get in late. The closer to expiration of the options, the greater the likelihood of them expiring worthless, assuming the stock is trading above the higher strike priced Put.

The stock price stays higher than the higher strike priced Put which will cause both Puts to expire worthless if you hold the spread until expiration. In this case, you keep 100% of the net credit you received when you executed the Credit Spread trade

or

The stock price stays higher than the higher strike priced Put which will cause the Puts to drop in value and the spread will shrink to a spread that is less than the credit you received when you executed the Credit Spread.
Management Of The Spread

Good spreads pretty much take care of themselves. The stocks may rise slightly, take off like a rocket or may even drop – but NOT equal to the higher strike priced Put.

Check the quote every day if you have time. Rarely will the stock ever drop so low in one day as to hit the higher strike priced Put.

You can also check the option quotes every couple of days too. You’ll notice that they start melting like an ice cube in the sun the closer you get to expiration.

Getting Out Early
You don’t have to wait until expiration, you can unwind the spread anytime you want. If you unwind the spread and the difference between prices is less than the net credit you received, then you profit.

Management of Spreads Gone Bad
Worst case scenario is that the stock is clearly dropping, something has happened that is taken negatively by the market and you want out.

The first thing to do is get on the phone with your broker, or get on-line into your account and “buy to close” the higher strike priced Put you’ve sold. By ‘buying to close,” you will have closed out the only position that can hurt you.
If the market is really dropping, the lower strike priced Put you own will rise in value and you can sell it at a profit.

Let’s say the market is not getting killed but the stock you spread is dropping, it hit your trip wire price and you want out.

You have two choices here:

1. 1. 1. “Buy to close” the higher strike priced Put you sold and stay long the lower strike priced Put to sell at a later date, assuming it rises.
      2. Unwind the entire spread. To unwind the entire spread you: “buy to close” the higher strike priced Put you originally sold and simultaneously “sell to close” the lower strike priced Put you originally bought.

This strategy is a low maintenance strategy that takes very little monitoring time and can easily generate weekly income for you. This strategy allows us to benefit greatly from the time decay of options.

It is more important to focus on the stocks than on the spread.
If you stick with the right stocks, you won’t have a problem getting stung using this strategy.

I always consider the strength of the stock first no matter how juicy a spread looks. I look at the stock, it must have a rising, fairly stable trend line with no major sell offs.

The chart has to look good. If you can’t see a rising trend line so apparent that a nine year old could see it, then move on.
Think “right stock” first, then right spread.

After I see a trend I like, then I look at the options and try to find a spread close to or below the price support I see on the stock when I look at the EMA’s.

If the spread isn’t there, then it isn’t there, just move on. Never find the spread first and then the stock.
Focus on the stock first, then look at the spread.

Where The Guinea Pigs Went Wrong
I collaborated with two other traders on this project when it came time to field test it. Both of them are experienced traders but had little experience with this strategy. They also had very good batting averages with this strategy but both of them deviated from the set up and execution in two different ways.

The first one would find the spread first and worry about the stock not dropping second. He found stocks with huge spreads because he was trying to get abnormally large returns. This approach turned out to bite him. Remember that the larger the spread, the more volatile the stock. When you see spreads like 1.75 you have to look at that as a sucker’s bet.
Don’t try to hit home runs on every trade.

The other guinea pig wasn’t as concerned about getting a large spread but he didn’t identify support as indicated by the EMA’s. Without looking at the chart, there is no reason to believe the stock could stay up until expiration. Remember, find the right stock first, then the right spread.

Questions and Answers

Q. Does the stock’s price matter when looking for stocks to use this strategy on?
A. No.

Q. What is the most important thing in selecting a stock to spread?
A. Strong trend and support deep out-of-the-money. Remember we don’t really need the stock to rise, we just need it to stay above the strike prices we have spread. As long as the stock stays above the higher strike price, the option will expire worthless.

Q. What is the exact process for unwinding the spread?
A. Buy back the higher strike priced Put you sold and sell the lower strike priced Put you bought. You can also just buy back the Put you sold without having to sell the lower strike price Put you bought.

Q. What EMA do you pay most attention to and why?
A. I pay more attention to the 50 day Exponential Moving Average because it shows a more accurate reflection of support and because it takes into account more trading days historically.

Q. Are there any other technical indicators you would use to identify support?
A. No, I’m not a big believer in technical analysis in general. The 20 and 50 day EMA’s have been the most accurate indicator I’ve ever used. I know there are more indicators out there but none have the historical accuracy of the EMA, in my humble opinion.

Q. Why do you always want to go deep out of the money?
A. Going deep out of the money insures our success ratio with the strategy. The further we are below the stocks current value, the greater the likelihood the option will expire worthless and we’ll keep all the credit.

Q. Do we have to hold the spread until expiration?
A. No, you can unwind the trade at any time. You are not required to hold the spread until expiration.

The option credit spread is a type of strategy used to hit singles and doubles and to collect premiums over and over again in as many markets as you want to trade in and as many times during the year as you can.

It’s a slow, steady gainer type of trade with an extremely high probability of profit. That’s why I love to teach it because the probability of winning is very high.

Benefits…
Best thing about this strategy is that you can do it with just $1,000. The reason is because with this strategy, the capital required is only the difference between strike prices X the number of shares under control. So for 10 options contracts with a one dollar difference in strike prices, your capital required is $1,000. If you net $100 on your spread, your return is 10% for the week. This is the way to make the most money on the little account. It also gives you the best edge in the market you can get. There is nothing better than this for accounts as little as $3000 all the way up to multi millions.

Creating Your Credit Spread

Finding Good Spreads

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