Trading SPX credit spreads can be a profitable strategy for both beginners and experienced traders in the options market. It offers limited risk, potential for steady income, and can be customized based on the trader’s risk tolerance and outlook on the S&P 500 index (SPX). This article will walk you through placing an SPX credit spread trade, explain key terms, and provide tips for maximizing success.
What Is an SPX Credit Spread?
An SPX credit spread is an options strategy where a trader sells an option at one strike price while simultaneously buying an option at a different strike price on the S&P 500 index. The trade generates a “credit,” or upfront payment, that the trader receives as income. There are two main types of credit spreads:
- Bull Put Credit Spread – Profits if the SPX stays above a certain price.
- Bear Call Credit Spread – Profits if the SPX stays below a certain price.
Both types of credit spreads come with limited risk and reward, which makes them a popular choice for traders seeking steady income while managing downside risk. At SPX Option Trader, we use both bull put and bear call credit spreads, selecting one based on our daily market forecast. To streamline our approach, we refer to entering a “credit spread” each day. When we open a call credit spread, we anticipate the market will move down, and when we open a put credit spread, we expect the market to rise—essentially the opposite of what you might initially think.
Step 1: Choose Your Trading Platform
To place an SPX credit spread trade, select a reputable options trading platform. Look for one that offers SPX options, has low commission fees, and provides tools for analyzing and managing your trades. Some popular platforms include Thinkorswim, Interactive Brokers, and E*TRADE.
Ensure that the platform allows for multi-leg option orders, which is crucial for setting up a spread trade efficiently. Also, confirm that you have the necessary approval level to trade spreads, as brokers often require a specific options trading level. A margin account is required to trade credit spreads, which also subjects you to Pattern Day Trading regulations.
Step 2: Anticipate Market Direction
The success of an SPX credit spread largely relies on accurately anticipating overall market direction. If you expect the SPX to rise or remain above a certain level, a bull put spread may be suitable. Conversely, if you anticipate the SPX to fall or stay below a certain level, a bear call spread might be the better choice. This is where our service becomes invaluable—we provide a daily forecast and specify the exact type of spread we are trading with our SPX Spread Trader. You won’t need to guess; we guide you with clear direction and all the details of the credit spread we’re entering.
We exclusively trade credit spreads on expiration day, allowing us to capitalize on the day’s volatility while ensuring all positions are closed by the end of the day. This strategy maximizes profit potential and minimizes overnight risk, making it ideal for those looking to benefit from same-day trading opportunities.
Here is an example of the alert we actually provided to our members on 10/18/2024:
We Plan to Open a SPX Vertical Credit Spread
Sell to Open .SPXW241018P5855 (SPX weekly option: put, Strike: 5855 Expiration: 10/18/24)
Buy to Open .SPXW241018P5850 (SPX weekly option: put, Strike: 5850 Expiration: 10/18/24)
For a minimum credit of 1.5
Armed with this insight, you now have what you need to gain an edge in your spread trading. In today’s Daily Outlook, we forecasted an up day, guiding us to enter a bull put credit spread. Keep in mind that when we enter calls in a credit spread, we’re anticipating a market decline, whereas entering puts in a credit spread means we expect the market to rise—essentially the opposite of what you might initially think.
Step 3: Calculate Profit and Risk
Before placing your trade, you can calculate the maximum profit and maximum risk to ensure the trade aligns with your financial goals. Here’s a quick formula for each:
- Maximum Profit = Credit Received
- Maximum Risk = Width of Spread – Credit Received
At SPX Option Trader, we consistently use a 5-point spread, meaning there’s a 5-point difference between the two strike prices. In our example, we executed a 5855/5850 bull put credit spread. Upon entering the trade, we received a favorable fill above our limit, obtaining a credit of 2.80, or $280 per contract.
Our maximum profit would thus be $280 per contract, achievable if the SPX closes above 5855. The maximum risk would be the 5-point spread minus our credit, or 5 – 2.80 = 2.20, equating to $220 per contract. If the SPX closes below 5850, this would result in the maximum loss of $220 per contract.
If the SPX closes between 5850 and 5855, our profit or loss will depend on the final price. For instance, a closing price of 5853 would yield a gain of $80, while a close at 5851 would incur a $120 loss.
Because SPX options are cash-settled, this profit or loss is automatically calculated by your broker after the market closes. By holding the spread until the close, you’ll receive the profit or loss based on the S&P 500’s final closing price.
On this day, the market moved exactly as we predicted, allowing us to hold our positions until the close and achieve the maximum profit of $280 per contract.
Step 4: Enter the Trade
Once you’ve selected your strike prices and calculated the potential profit and risk, it’s time to enter the trade. We enter our Spread Trades using the same entry conditions as our Daily Outlook. Here’s how to do it step-by-step:
- Navigate to the Trade Tab: On your trading platform, open the options chain for SPX and select the expiration date you wish to trade.
- Choose Your Strike Prices: Select the strike prices for your options.
- Enter as a Spread: Enter the order as a multi-leg order to create a spread. On most platforms, this can be done by choosing the “vertical spread” or “credit spread” option.
- Set the Credit Amount: Input the credit amount you’re aiming for. It’s generally advisable to set a limit order rather than a market order, as this helps ensure you receive a favorable credit for your spread. We share each day the limit we are using in our Spread Trader.
- Review and Place the Order: Double-check your order details, including the strikes, expiration date, and credit amount. Once everything looks correct, place the order.
Step 5: Monitor and Manage the Trade
After placing your SPX credit spread trade, you should monitor it through the day. Here are a few key points for managing your trade:
- We usually hold our positions until market close, at which point profits or losses are realized. Once you’ve entered the trade, you can simply wait for the market to close
- If we decide to exit early for any reason, we promptly inform our members. Some may opt to close their positions early due to market volatility. On certain days, exiting early can help minimize losses, while on others, it may mean forgoing potential profits. Our objective is to maximize profits and minimize losses each day. If market conditions suggest an early exit, we provide timely alerts throughout the day.
- To exit an SPX spread trade early, simply reverse the steps taken to enter the trade and close it with a single order.
- Most brokerage platforms allow you to select your current spread position and place an order to exit the trade easily.
Final Thoughts on SPX Credit Spread Trading
SPX credit spreads offer an effective way to generate income with defined risk, making them appealing to traders seeking stable returns. By following a structured approach—choosing the right platform, analyzing the market, setting strategic strikes, calculating risk, and managing trades—you can optimize your chances of success with SPX credit spreads.
Remember, while credit spreads provide a level of protection, they still carry risk, especially in volatile markets. Start with smaller positions and always use a disciplined approach to protect your capital.