Comparing Underlying Indexes to Trade Bear Call or Bull Put Credit Spread Options – RUT, IWM, SPX

Question:  Can you tell me why you prefer RUT over SPY and SPY over SPX when opening credit spread options?

Answer:   The RUT provides the best strike price placement, usually above past resistance levels and below past support levels, while paying a nice premium when opening a bear call or bull put credit spread options.  It also has good liquidity, i.e. a high number of options contracts are traded daily on the RUT, which allows us to easily get into and out of our trades. 

The next best underlying index to trade credit spread and iron condor options is the SPY, (and ETF that tracks at 1/10th of the value of the  S&P 500 index – SPX) but in order to get the best return we need to open 2 point wide spreads, which has a drawback.  (a 2 point wide spread has two points between the leg that we sell and the leg that we buy)  The negative of a 2 point wide spread, as compared to a 10 point wide spread that we would open on the RUT, is that we have to open 5x the number of spreads to allocate the same amount of cash and this has higher commissions.  Also, the liquidity is very high on the SPY….i.e. a million or more options contracts change hands every day – and this is both good and bad.   The good part is that we can easily get in and out of trades….even during volatile times when the market is moving a lot.   The bad is that when the market is bouncing…and let’s say we need to make an adjustment or roll the spread, because there is so much liquidity we have to pay what the market is asking (between the bid and ask prices)  and we rarely can get a special low price that is outside the bidask price range.   On the other hand, if the market is moving a lot and we need to make an adjustment on the RUT, many times we’ll be able to get a cheap price that is outside of the bid/ask prices.

For a case study that compares and contrasts 2, 3, 4, 5 , 7 and 10 point wide credit spreads on the SPY please go to the Learning Center at http://www.monthlycashthruoptions.com/LearningCenter.htm  and read entry #6 – “why we usually open 2 and 3 point wide spreads on the SPY and IWM”.  

Regarding the SPX, you have to be super careful in trading credit spreads and iron condors on this underlying index.  I liken it to Hotel California….it’s really easy and everyone is friendly when you check in, but when things get ugly and you need to get out of your trade, you’ll usually get your head handed to you. (i.e. it will cost a lot to close out your spread and you’ll probably take at least a 25% loss)    Overall, do your best to avoid trading credit spreads on the SPX.

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