Setting up a Bull PUT Spread, AKA PUT Credit Spread, the Money Machine if done right

What Is a Put Credit Spread?

A Put Credit Spread is an options strategy that I use when I expect a moderate rise in the price of the underlying asset, here The S&P500 and its ETF the SPY. This strategy employs two put options to form a range, consisting of a high strike price and a low strike price.
When you sell a spread, you receive a credit for the trade because the Short PUT is closer to the money and hence creates a bigger premium and the HEDGE, the Long PUT is further OTM and hence is cheaper. The sum of the spread is your Premium earned upfront. Like selling car insurances but here we do it for stocks and ETFs. And I am using similar statistics to determine the Price of the underlaying and its deviation from the mean and hence we calculate the probability of losing a trade /winning a trade. 

It is good to have a 90% winning rate on Spreads.

That means I receive cash up front for the trade! Credit spreads are risk defined spreads so my max profit and max loss are both defined before I even place the trade.
Max profit is the credit I receive for selling the spread - you can't make any more money than the initial credit received. Max loss is the difference between the width of the spread and the credit received for selling the spread.

For further reading:
http://tastytradenetwork.squarespace.com/tt/blog/4-keys-to-placing-your-first-credit-spread
https://www.investopedia.com/articles/optioninvestor/02/041202.asp

What happened today

We sold a 370/350 vertical PUT Spread, Expiration May-14-2021 for a $1.68 premium.

This means $1.68 x 100 Shares for one contract. If you traded 5 contracts this would amount to $840.00 premium. These trades you establish on a weekly base and close them after 2 weeks. With a not fast moving market /S&P500 (which is the market) we can constantly turn in a profit on a weekly base.

This number amounts to about 4 time $840 = $3,360.00 a month. With a 3.44% Failure rate, you will see later why, the amount should be reduce to about 96% = $3,225.00. Deduct $6,600 losses, see below for details. It comes to about a 84% total Gain in average!

So now include these trades for not only SPY but also for other slow moving ETFs like QQQ and DJI. Here is your path to a good monthly income of $10,000.00.

With closing the trade we can either wait until expiration of the option on May 14th and they just disappear from our portfolio and we keep the money or we buy them back at a much reduced price due to the fact that the underlaying is moving up and time decay Theta eats away the option price. OR the underlaying doesnt move at all or slightly down and we just profit of Theta. We want to exit in about 2 weeks for a 50% of the max profit. A win/win either way.

Why would we do that instead of letting it run to expiration?

The reason is The success rate is statistically much higher if you close it after 14 days or between 50-75% of max profit than waiting to expiration to squeeze the last Dollar out of it. The daily P/L will go up and so does the Risk / Reward Ratio and the Kelly Criterion which is important to measure your performance as a trader.

How do I determine the Strike levels?

I run historical price data on SPY and all other assets!!! That is the fundamental analysis. We dont pick investments due to feelings or if we like them or due to lines on a graph. This is for amateurs. We pick what makes us money. 

If you like the Casino you better own the bank,

do not play the slot machines. 

When you statistically analyze historical data of the assets you will find out how much the distribution of the underlaying is diverging form a normalized distribution. You will also find out what the standard deviations are and how many times they get hit in the data set.

Statistics are great!! They put the odds in your favor. Since I enter at 3rd Deviation it means that actually my trade will be established at the END of the Deviation. Not the beginning. 

What are the chance to get hit and triggered?

In the data of the past 5 years we find that 3rd Standard Deviation for the SPY (Upside and downside), is only triggered less than 1%. Since the SPY is tending more up and has a positive gain on a yearly base the Deviation is skewed to the upside. 

The 3rd Standard deviation is triggered statistically less than 1% BOTH sides!

If you know a little bit EXCEL and can find your way through formulas this is an easy piesy.

Here we have the Short PUT Entry and the Long PUT Entry calculated. They are at 375 and 350. And since the numbers are a little overlapping the Trigger Rate is a little higher and sits at 3.44%. We can also see if the underlaying moves against our position at average rate it will just slightly hit us after 4 weeks with 377 to 375. Will the underlaying move 4 weeks against us? Very unlikely.

In a Black Swan Event it is likely, like COVID in 2020, Oil Crises in 2013, Housing Crises in the US in 2006, the DOT COM Bubble Burst in 2000, yes. Those events happen every so often. 

What is the Stop Loss Level?

Lets do some math here because if this strategy is all about numbers we totally exclude emotion.

SPY is $400 today and according to our statistics the underlaying can move up in average by $5.00 a week. This is the uptrending black arrow. Since we close within 14 days as a target we shall close at 16th of April, the yellow vertical line. Under average circumstances the price of the underlaying can be anywhere between $410 (Gain of $650) and $390 (Loss of $330) if executed. But then we wait longer if negative!

The green staggered green arrows indicate the 50% of Max Profit mark. We see that the longer we wait the Profit level gets lower and lower. This is Theta, the time decay in an option.

This means if nothing happens and we just wait we will still be profitable at an even lower stock price.

I love Options!!

Our Stop Loss will be at 20% of Max Loss. Here at $11,000.00 it would mean if the trade runs close to our STRIKE of the Short PUT, $375 we bail out with a loss of $2,200. That seems a lot but is not!!

Our success rate is under normal conditions about 97% or more. Only 3 out of 100 trades will generate a $2,200 loss. A total of $6,600. Compare this to 97 x $840 x 50% = $41,000

With all those 3 trades that hit the Strike Level you would end up with a 16% total loss over 100 trades. So whatever your allocated capital is every dollar you would turn into a profit of ONE Dollar and 84 cents! This is a money machine. 

One more important thing is to set up Alarms to get notified if your position runs through a certain level! Very important.

But you will only get it if you are abstract savvy. Think about it.

Max Loses sound gigantic but they just tell the story of  an unprotected position. As when you buy stocks and then you don't put a management or Stop Loss Order in place to limit your losses, your stock can go out of business over night and all your investments are zero. That is a max loss in stocks. Here its similar. 

http://opcalc.com/sJb

These data can be obtained publicly and dont cost anything. You should be familiar with programming Excel though. If not pick the OPTION with a DELTA of less than -0.10 which equates to less than 10%

Thats why in the beginning I deducted 3.44% since 3.44% of trades will be losers over time. Those trades will be closed when they fall through the Strike Level of the Short PUT.

Who is the bank?

I guess whoever understands this and there are not many since we all are so brainwashed and financially illiterate, can make a fortune over time. Most people feel intimidated because it hurts their feelings. I dont care.

If your winning strategy is 96.56% than you are the bank! This is the same reason and comparable to insurance companies. You buy car insurance but dont want to have an accident. But you pay monthly to the insurance company. It is the same here with PUT Spreads. You sell insurance to the asset owner! You earn premiums every time you sell. And the ocean is limitless.