Complex? I hope not. Let's say we do 10 of these, with a month left until expiration. So our maintenance is $9,350, plus the $650 we took in (which isn't ours yet), for a total of $10,000. It's our money, in our account, earning our interest - it's just restricted until expiration.

Now, remember, the SPX index is at 770. Anything can happen, but we did this trade knowing there was only a 7% likelihood that SPX would expire in March at 610 or below. We know this by looking at the "delta" of the 610 option, which any good options broker will give you. I like those odds.

The Difference Between a Pro and an Amateur

And I use that heading with all due respect, because I've been both. But the difference between a person who consistently gains using this strategy, and one who gains a lot and then gives a chunk back, it very simple - risk management. Remember that "delta" of the short option? Well, that's a moving target. The closer the market moves to that strike price, the higher the delta (risk) goes - except that each passing day pulls that delta back down a little.

Now, we've done a credit spread that is WAY out of the money. Our goal, very simply, is for the SPX to expire above that 610 short strike - even at 611. If that happens, we keep the $650; the $9,350 is freed up to use for a new trade; and life is good. And, this will happen 93% of the time based on this trade's initial odds. It's that 7% that will kill us, because our $9,350 is then potentially at risk. If the SPX closes at 609, we will lose the $650 we took in plus $350 or our own money. But, if it closes further down, we lose more, or even all, of our $9,350. Remember, our maximum loss is at SPX 600 - anything lower than that and we still only lose our maximum - but that amount is HUGE!

So, to manage our risk, we monitor that "delta" as time passes and the market fluctuates. If the market goes way down, quickly, we'll see that delta creep up to our limit of 25%. At that time (which won't happen often, but it WILL happen), we calmly take action. We're not suddenly at risk; we've just triggered our action mechanism. We've got several choices - but it's time to take one of them. That's a subject for another article - but essentially, we want to buy back our now "challenged" position, and possibly sell a new one with around a 7% delta to offset some of the cost of buying back the old one. Wait. Did we just suffer a loss? Well, maybe. If we only do one credit spread at a time, then yes, we'll incur a loss on occasion. I do several a month, using different indexes and different strike levels. That way, I have a "bucket" of money taken in, that I can use a small amount of to offset a loss.

The Other Side of The Coin

Earlier, I mentioned Iron Condors. If you know what they are, there's still a twist. If you don't, it's a pretty cool name, isn't it?

Remember how we used puts for our SPX credit spread? Well, you can use the same process to do a call credit spread too. In the above example, with the SPX at 770, we did a put spread about 160 points out of the money, and took in about $.65. However, we can also do a call with the same expiration. To get the same probability of success, we might sell the March 930 call, and buy the March 940 call. We won't get $.65, but we might get about $.40. And guess what? No additional margin. The SPX can expire in March either way up, or way down, but not both! So now, on one contract, we will have taken in $105, and we have $935 at risk. For the one month that we have our money at risk, that's an 11% return. And if we could sustain that return for a year, without compounding, our annual return would be 136% (more than doubling our money). This ignores commissions and income taxes, both of which you have to pay. But it gives you a great illustration of the potential.

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