By Brad Reinard. Editor-in-Chief, monthlycashthruoptions.com

Last Update August 6, 2009

This case study analyzes and compares the credit spread option trading strategy of 1, 2, 3, 4, 5, 7 and 10 point credit spreads on the SPY.  The SPY is an ETF that tracks at 1/10th the value of the S&P 500 index.   We make the case that the 3 point credit spread is optimum and provides an excellent risk-adjusted return, minimizes the commission hit, it gives us flexibility to make adjustments when needed if the credit spread gets under pressure, and it keeps the required maintenance level low enough to allow investors with different account sizes to participate in this option trading system.

Here are the assumptions used when making our calculations on this option trading system:

1) Commission = $1/options contract or $2/ credit spread. (we show additional commission rates in the spread sheet summary below)

2) $5000 of cash is available to open the spreads

3) The trade stays out-of-the-money (OTM) and profitable, and we let the spread expire worthless, which is 100% profitable for us, the seller.  Thus, we only pay commission to open the credit spreads and we call this one-way commissions. (in contrast to round-trip commissions where we pay to open and close the trades)

4) All spreads have 31 days until expiration

5) We simplify the number of spreads that we can open by dividing the available $5000 of cash by the required maintenance.

Below is the SPY Aug 89/90 option trading strategy bull put spread which has the following characteristics:

1) Its a 1 point credit spread (i.e. 1 point between the sell leg and the buy leg)

2) Required maintenance by the broker is $100 per option spread (1 point spread * $100/point)

3) 50 credit spreads can be opened ($5000/$100 of required maintenance per spread)

4) Premium collected is $15 credit x 50 spreads = $750

5) Risk capital is $5000 in maintenance $750 of premium collected = $4250

6) One-way commission at $1/contract is 50 spreads x $2/spread = $100.

7) Commission as a % of premium collected is 100/750 = 13.3%

8) ROI after one-way commission is (750-100)/4250 = 15.3%

Below is the SPY Aug 88/90 option trading system bull put spread which has the following characteristics:

1) Its a 2 point spread option (i.e. 2 points between the sell leg and the buy leg)

2) Required maintenance by the broker is $200 per spread (2 point spread * $100/point)

3) 25 credit spreads can be opened ($5000/$200 required maintenance per spread)

4) Premium collected is $25 credit x 25 spreads = $625

5) Risk capital is $5000 in maintenance $625 of premium collected = $4375

6) One-way commission at $1/contract is 25 spreads x $2/spread = $50.

7) One-way Commission as a % of premium collected is 50/625 = 8%

8) Return for this option trading system after one-way commission is (625-50)/4375 = 13.1%

Below is the SPY Aug 87/90 option trading strategy bull put spread which has the following characteristics:

1) Its a 3 point spread option

2) Required maintenance by the broker is $300 per spread option

3) 16  credit spreads can be opened ($5000/$300)

4) Premium collected is $35 credit x 16 spreads = $560

5) Risk capital is $5000 in maintenance $560 of premium collected = $4440

6) One-way commission is 16 spreads x $2/spread = $32.

7) One-way commission as a % of premium collected is 32/560 = 5.7%

8) Return for this option trading strategy after one-way commission is (560 32)/4440 = 11.8%

Below is the SPY Aug 86/90 option trading system bull put spread which has the following characteristics:

1) Its a 4 point spread

2) Required maintenance by the broker is $400 per credit spread

3) 12 credit spreads can be opened ($5000/$400)

4) Premium collected is $44 credit x 12 spreads = $528

5) Risk capital is $5000 in maintenance $528 of premium collected = $4472

6) One-way commission is 12 spreads x $2/spread = $24.

7) One-way commission as a % of premium collected is 24/528 = 4.5%

8) Return for this option trading sytem after one-way commission is (528 24)/4472 = 11.2%

Below is the SPY Aug 85/90 option trading strategy bull put spread with the following characteristics:

1) Its a 5 point spread

2) Required maintenance by the broker is $500 per spread

3) 10 credit spreads can be opened

4) Premium collected is $50 credit x 10 spreads = $500

5) Risk capital is $5000 in maintenance $500 of premium collected = $4500

6) One-way commission is 10 spreads x $2/spread = $20

7) One-way commission as a % of premium collected is 20/500 = 4%

8) Return for this option trading strategy after one-way commission is (500 20)/4500 = 10.6%

Below is the SPY Aug 83/90 option trading system bull put spread with the following characteristics:

1) Its a 7 point spread

2) Required maintenance by the broker is $700 per spread

3) 7 credit spreads can be opened ($5000/$700 required maintenance per spread)

4) Premium collected is $58 credit x 7 spreads = $406

5) Risk capital is $5000 in maintenance $406 of premium collected = $4594

6) One-way commission is 7 spreads x $2/spread = $14

7) One-way commission as a % of premium collected is 14/406 = 3.4%

8) Return for this option trading system after commission is (406 14)/4594 = 8.5%

Below is the SPY Aug 80/90 option trading strategy bull put spread with the following characteristics:

1) Its a 10 point spread

2) Required maintenance by the broker is $1000 per spread

3) 5 credit spreads can be opened

4) Premium collected is $65 credit x 5 spreads = $325

5) Risk capital is $5000 in maintenance $325 of premium collected = $4675

6) One-way commission is 5 spreads x $2/spread = $10

7) One-way commission as a % of premium collected is 10/325 = 3%

8) Return for this option trading strategy after one-way commission is (325 10)/4675 = 6.7%

www.monthlycashthruoptions.com/LearningCenter.htm  and read the entry Why we usually open 3 point credit spreads on the SPY.    If you would like access to this spreadsheet, please contact us at support@monthlycashthruoptions and well forward it to you.

www.monthlycashthruoptions.com/WhyMarketTiming.htm .   For more on the staying ahead of the wave strategy, please read the entries what if the market surges, how do we protect ourselves? and what if the market crashes, how do we protect ourselves? in the MCTO Learning Center .

About The Author

Brad Reinard is Editor-in-Chief of Monthly Cash Thru Options LLC, a leading index credit spread & iron condor options advisory newsletter.   For more information please visit www.monthlycashthruoptions.com  or call Brad directly toll-free at 877-248-7455.  Monthly Cash Thru Options LLC is located in San Jose, California, the heart of Silicon Valley.