Option strategies that limit your risk: Sell Double Credit Spreads

The Sell A Double Vertical Spread strategy offers an alternative to traders who are not comfortable with the unlimited risk associated with selling a straddle/strangle. Selling a straddle/strangle strategy consists of selling an out-of-the-money call and put. The Sell A Double Vertical Spread strategy does this and also purchases a further out-of-the-money call and put. The advantage is that this allows a trader to profit from time decay while eliminating the threat of unlimited risk. The disadvantage is that the profit potential is reduced by the amount paid to purchase the further out-of- the-money options. This strategy will be used primarily when:

1. A. You feel confident that the underlying stock or futures contract will remain in a particular range,
   
2. B. Volatility is high enough to justify selling premium,
   
3. C. You are not comfortable selling naked options and want to limit your risk.
   

To set up a double credit spread, the trader would do the following:

If XYZ is trading at 100

Sell 10 Aug 95 Puts @ 5

Sell 10 Aug 105 Calls @ 6

Buy 10 Aug 90 Puts @ 4

Buy 10 Aug 110 Calls @ 5

By selling the 95/105 spread, the trader is essentially selling a strangle and exposing himself to unlimited risk on both sides of the trade. To protect himself from unlimited risk, the trader then purchases further out of the money puts and calls which still results in a net credit.



When To Exit Double Vertical Spreads

Choice 1:

• Establish the trade so that your maximum risk on this particular trade is below your maximum allowable risk level for any given trade and then simply hold trade until expiration.
  

Choice 2:

• Exit trade when 80-90% of maximum profit is obtained. This will involve paying 4 more commissions when trading stock options.