A credit spread is commonly traded as an income-generating strategy. The
idea is simple: sell the option closer-to-the-money and buy the more out-of-
the-money (OTM) option—that is, sell volatility—and profit from
nonmovement (above a certain point). In this example, with Apple at $391,
a neutral to slightly bearish trader would think about selling this spread at
4.40 in hopes that the stock will remain below $395 until expiration. The
best-case scenario is that the stock is below $395 at expiration and both
options expire, resulting in a $4.40-per-share profit.
The strategy profits as long as Apple is under its break-even price,
$399.40, at expiration. But this is not so much a bearish strategy as it is a
nonbullish strategy. The maximum gain with a credit spread is the premium
received, in this case $4.40 per share. Traders who thought AAPL was
going to decline sharply would short it or buy a put. If they thought it would
rise sharply, they’d use another strategy.
From a greek perspective, when the trade is executed it’s very close to its
highest theta price point—the 395 short strike price. This position
theoretically collects $0.90 a day with Apple at around $395. As time
passes, that theta rises. The key is that the stock remains at around $395
until the short option is just about worthless. The name of the game is sit
and wait.
Although the delta is negative, traders trading this spread to generate
income want the spread to expire worthless so they can pocket the $4.40 per
share. If Apple declines, profits will be made on delta, and theta profits will
be foregone later. All that matters is the break-even point. Essentially, the
idea is to sell a naked call with a maximum potential loss. Sell the 395s and
buy the 405s for protection.
If the underlying decreases enough in the short term and significant
profits from delta materialize, it is logical to consider closing the spread
early. But it often makes more sense to close part of the spread. Consider