Learn to Sell Vertical Put Credit Spreads (Lesson 5)

Welcome to the fifth lesson on how to sell Vertical Put Credit Spreads. You should have gone through the prior lessons and sold both a covered call and a cash-secured put and managed the positions during expiration.  These trades are what I like to call covered and in my opinion are two of the safest options trades.  When I was first learning I repeated these trades several times and learned the intricacies of trading options.  I suggest you do the same.  Once you feel you have the nuances down you can move onto another strategy that is a bit more complicated but is also what I consider to be a safe trade.  What I am referring to is selling vertical put credit spreads.

For this lesson, I am only going to discuss the put side of these trades.  The vertical call credit spread works in a similar fashion, but I feel it is a lot riskier.  This is since the stock price can go on a tear and keep increasing to an amazing degree.  An example of this is NVDA which went from $140 to over $800 back in 2021.  If I sold a vertical call credit spread and did not own the stock, I would be in a world of hurt.  For a vertical put credit spread, you are limited by how much the stock can go down.  Meaning it cannot go below 0.  Also, if you choose good value dividend stocks then they typically do not decrease much.

The easiest way to think about the vertical put credit spread is its two trades in one.  The first trade is just like the cash-secured put.  You choose the contract the same way.  Identify a good strike price, expiration, and premium.  Look for contracts that have a delta of near -.15 or 85 percent probability of expiring out of the money.

Let us use an INTC contract as an example to clarify how this works.   The price of INTC back in July of 2021 was 55 and I found a good strike price of $50 with an expiration of 44 days.  It pays $1 in the premium or $100 total for the 100 shares in the contract.

Now I look for another contract that is $10 cheaper or $45 that expires on the same day.  However, I buy this contract and pay $.30 for it.   So, I receive $70 net for the two trades.  By buying the outer arm at $45 I also limit my risk and decrease the required margin.  In this case I only need $500 ((50 – 45) * 100) – $70 net premium or $430 for the margin.  This is because if INTC goes below 45 I can have the shares sold to limit my loss.  In most cases, if you are deep in the money, you can close both contracts before expiration with a minimal loss.  Below is how it looks in my trade journal.  This is from a trade I did back in May 2021.

So, this trade is a bit more complicated due to having to do two trades.  It is referred to as a vertical because the strike prices are both on the same expiration day.  It is a credit because you are taking in a net gain for the two trades.  Now that you know the basics you can go ahead and do your first Vertical Put Credit Spread using the steps below.

1. From the broker research page, enter the desired ticker symbol.
2. The system should display investment information. (Charts, Summary, News, Ratings, …)
3. Click on Options on the tab menu on Schwab. Trying to get to the options chains. 
4. Expand the options to show the expirations for the contracts.
5. Identify the contracts that are near a -.15 Delta or 85% probability. (In the drop down on the top left of the chain page you can select Greeks.)
   
6. Click on Trade for the desired option contract. You will be brought to the trading page.
7. Select for strategy the Vertical Put under the 2 Leg Spreads category. Each trade is referred to as a leg.
8. Leg 1 – “Sell to Open” trade.
   1. Enter the strike price and expiration date. This should be the higher strike price of the two trades.
   2. Enter “Sell to Open”, the number of contracts (1).
9. Leg 2 – “Buy to Open” trade.
   1. Enter the strike price and expiration date. This should be the lower price of the two contracts.
   2. Enter “Sell to Open”, the number of contracts (1)
10. Select Market order for the order type. The system should refresh and show you the net value of the overall trade.  You can change strike prices and expiration to see how your net results for different iterations.
11. Verify selections on the screen and then click the Review Order button.
12. Check everything to be sure the order is correct and then click submit to process the order.
13. Since this is a market order, you get an immediate order status that showed that it was processed. I prefer market orders because I do not want to be constantly trying to get a better price.  I am typically good with the market order premium.  This allows me to minimize the amount of time I spend trading.

Here is an image of what the overall trade looks like on Schwab.  This is as of 7/9/21 at 11 am and is actual values from the market.

The first couple of times you do this it will feel a bit odd.  It did for me.  Now it has become second nature.  I have found that I do few cash-secured puts now.  I mostly do Vertical Put Credit Spreads but also have the necessary cash if I get assigned.

When you near expiration for Vertical Put Credit Spreads you have the same alternatives as covered calls and cash-secured puts.  You can let them expire or be assigned, close them, or roll them out to the future.  Lesson 6 discusses how to manage these trades in more detail.  You can access it here.  Congrats on making it through the first five lessons.  You now have some good knowledge on how to sell options.  Like me, you have taken the first steps to open a door to investing that most people know little about.

Thanks for Tuning In!!

I also have a YouTube video on a Vertical Put Credit Spread that I sold.  You can see first hand what its like.