Wednesday, January 25, 2012

Credit Put Spreads Part 4 - Delta Selection

   Delta selection – closely related to probabilities is the selection of the short strike for the credit put spread.  My criteria is that the short strike must have a delta of 25 or less. Preferably 20 or less. As a quick reference a 20 delta gives you an 80%probability of profit, 15 delta is 85% probability. The probability calculator on the broker website will calculate it more accurately but it gets you in the ballpark. Anything higher than 25 delta starts getting closer to at-the-money which by definition is a 50delta, ie a 50-50 situation. You may choose a higher delta in order to get more premium but I am comfortable with 25 delta or below.
      So when identifiying a stock to look at, i pull up the options chart and my eye goes quickly to the delta column looking for the 20 or 25 level. Anything higher than that usually gets eliminated from consideration. Like in probabilities section, there will be many profitable trades with deltas higher than what im looking for. The higher the delta the higher the premium you receive but the lower your likelyhood of a profitable trade. Again i let the probabilities (delta) drive the selection process for entering trades, not the premium received.

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