SPX Credit Spread and the Option Greeks

Yesterday saw a nice advance on the S&P 500 and the market's other major averages. That's good for our bull put spread because it expands the distance between the market and the strike of our short put option. This trade is working out nicely and I'll start looking at March for trading opportunities.

The SPX has not really traded that far from where we sold our credit spread. Favorable directional movement will help us by decreasing the value of our spread, but the primary profit driver is theta. The reason directional movement is not as helpful as you might think is because by its nature a vertical spread is a hedged position.

Each option has its own set of greeks. When you buy one option and sell another, such as in a bull put spread, you have one position with a positive delta and another with a negative delta. The delta values will be slightly different, because one option will be a bit closer to the money than the other. Nonetheless, when the market moves both options are simultaneously effected.

When the market moved away from our bull put spread, the short option lost value which generates profits for us because we can close the position for less money than we received when it was originally sold. However, we also bought an option which is also worth less. Those losses on our long put option contract will offset most of the profits from the short option contract.

Because we are losing money on our long option, that favorable directional movement does not help us as much as you might otherwise think. Only an extreme directional move, that rendered both options essentially worthless, would allow us to exit the trade with the required profit. Absent an extreme market move, what we really need is for theta to whittle away at the position's combined time value.

So, the delta of the long and short option offset each other. If the deltas offset each other, why are we concerned about an unfavorable move toward our position?

We'll pick up with that tomorrow. If you are not a subscriber to our newsletter or mini-course, you can subscribe without cost or obligation to learn more about options and our trading methods.

Trade well and mind your risk!

Christopher Smith
TheOptionClub.com