Vertical Spread - How To Generate Reliable Monthly Income From The Stock Market
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A preferred non directional trading strategy is the option Vertical Spread. This strategy is one of the easier option spreads to comprehend for newer option traders. In addition it is simple to place and there is not much to do management wise while the trade is in play - which allows the vertical spread trader to be freed from their trading chair and not have to watch every up tick and down that the market makes all day.
The vertical spread trade is a basic building block of many if not most other more complex option trading strategies such as the iron condor spread, the butterfly, and the double diagonal trade. For example, the butterfly is created using one credit spread and one debit spread, while the iron condor is made up from two credit spreads, one on either side of where the underlying is currently trading at.
Option traders love to trade this strategy because the way these trades are constructed can allow the trader to be wrong and still make money. If the trader creates a particular credit spread position, he or she can win if the stock or index being traded winds up doing three out of four possible scenarios. If the stock goes down, the trader makes money. If the stock goes nowhere the trader makes money. If the stock goes up a little, the trader makes money. The only way the trader can lose money if the stock goes up far enough to threaten the vertical spread that has been sold. And even then, there are management and adjustment techniques that can be utilized to hedge against losses.
Let's create an imaginary trading scenario to illustrate. Imagine that a trader believes that a particular stock will be heading down in the short term. Because he is bearish on this stock, he sells a bearish credit spread called a bear call spread which benefits from bearish move.
If the stock does move down as our trader anticipates, this spread trade wins. If the stock does absolutely nothing and just remains trading at it's current level, this trade wins. Even if the stock moves up against our traders outlook, this trade can win just as long as it doesn't move up too much. The only way this position will lose money is if the stock moves too high too fast - in which case the trade could still be profitable just as long as our trader knows how to properly manage and adjust the position.
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