Hey Trader,

If the phrases “iron butterfly,” “long guts,” “condor,” “straddle,” “calendar spread,” “diagonal spread,” or really any other mention of a spread trade makes you want to turn around and run away from your trading account…

You’re not alone.

But you are missing out on some potentially VERY lucrative trading opportunities …

Because too many traders buy into this one common misconception about options trading:

“Complex spreads are for advanced traders only, and are too difficult for a trader like me.”

Look, in this case, “complex” doesn’t have to mean “more difficult.”

In fact, you could argue that in many ways, trading spreads is actually EASIER than straight call or put buying.

Now, I understand a lot of traders have quite a bit of apprehension about trading spreads.

Especially if you’ve been taking shots trading straight calls and puts with less-than-stellar results.

Here is the thing, though … those “simple” plays aren’t as simple as you might think.

Let’s look a little closer … 

When you buy a call on a stock, you might think you are simply saying “I believe XYZ will go higher.”

But there are many more facets to it than that. 

Because of course, not only are you betting on XYZ to go higher, but you are betting on it to go a certain amount higher, by a certain date.

And even if you’re right about the direction of the move, the size of the move, AND the timeframe of the move …

You also need to take into account other option pricing factors as well.

For example, time decay eats away at the value of your option every. single. day.

And of course, you can’t forget about implied volatility (IV), which can have a HUGE effect on an option’s price, regardless of what the underlying is doing.

For example, let’s say you’re correct about the timing and direction of a stock’s post-earnings move … 

But after earnings, suddenly all of the IV is sucked out of your option (in what’s called a “vol crush”) and suddenly your now-winning option is actually somehow worth LESS! 

Your trade – which you were RIGHT about – still isn’t profitable because lower implied volatility has annihilated the price of your option.

And of course there is the matter of your trade budget.

For most of us, practicing good money management in our trading accounts means we can only afford to spend so much on a single trade.

So if your budget isn’t high enough to get the option you REALLY want … maybe you’ll look for a cheaper workaround, like moving a few strikes further out of the money.

Unfortunately, this often backfires, and instead of spending more money on a winning trade, you’ve spent less money, but lost it all. 

The solution to these problems?

Spread trading!

Shhh … Your Broker Doesn’t Want You To Know This!

Now, don’t be intimidated by spreads. 

Your broker wants you to think they’re strategies reserved only for the most-advanced traders …

But that’s simply not true.

In fact, let me let you in on a little secret …

Your broker doesn’t want you to spread trade because they don’t make as much money off of it.

They want you to make simple options trades so they can make their quick and easy profit on the bid-ask spread. When you execute a spread trade, they typically don’t make as much profit off of you.

Plus, frankly, it’s easier to win with spreads (I’ll get to why in a minute), so the people who profit off of you losing want to scare you away from these trades because they don’t want you to win.

You can decide for yourself … but personally, I could care less about “their” best interests – especially if it’s at the cost of my own bottom line!

Spread Your Wings (And Your Trades!)

All right, so we’ve gone over the downside of simple trades, and why you’ve been led to believe that “spreads” are sooo difficult.

So now let’s look at what makes spreads such a great trading tool.

First of all, many spreads allow you to determine your EXACT risk, and EXACT reward, when you place the trade.

For example, take a long call butterfly.

(This is one of those trades that might send many traders running for the exit, but bear with me. All it is is buying one in-the-money call, writing two at-the-money calls, and buying one out-of-the-money call. You’re basically just executing three “simple” trades at one time.)

As soon as you make the trade, you already know your maximum profit, and maximum loss.

If the underlying stock is at the strike-price of the written calls, you achieve max profit, which is equal to the strike of the written option, minus the strike of the lower call, minus the premium paid.

Your max loss is just the premium paid.

Not so “complex,” huh?

This makes it easier to assess your risk/reward profile, and because you’ve already controlled your risk, the trade is actually generally easier to manage.

Now, remember the “other” pesky pricing factors like IV and time decay (theta)?

With spread trades, you can either minimize the effect of these, or even specifically trade them. 

For example, if you buy a call option that decays $0.10 per day, and sell a call option that decays $0.05 per day, you have actually lowered your total time decay to $0.05 (since you make money as the sold call option decays).

Implied volatility works similarly, so if implied volatility decreases, your long option may suffer, but your short option will benefit.

Another handy perk of spread trades is that by buying an option and selling another, you’re able to decrease the overall cost of your trade.

This opens up your options (no pun intended) by widening your budget, which lets you be more choosy about strikes, and also target options further out.

For example, if your budget per trade is $500, and the at-the-money call you really want is $6.50, you can sell an out-of-the-money option for $1.50, and lower the cost of your at-the-money call purchase!

Of course, you always need to monitor potential risks when selling options, but like we talked about above, with many spread trades, your risk is already defined!

We will be talking a lot about spreads in the upcoming weeks … send a note to  [email protected] if you have any specific spread questions you’d like to see answered!

Your Only Option,

Mark Sebastian