Using Max Pain to Sell Credit Spreads

I’m like you, I want to score big with some long or short naked option buys. It’s a great feeling when I buy calls or puts and I get in just at the right time and get out before the trend moves against me. That kind of trade requires a great deal of attention to technical indicators, takes a lot of experience, intuition, and last, but certainly not least, luck. So while I still try to sharpen my skills in that arena, I have found a more consistent, but less exciting way to earn income weekly. I become one of the big guys and sell premium (I really don’t know who the majority of premium sellers are, perhaps they are in fact scrawny and short, but I imagine them to be the institutions).  So, why not join their party and sell with them. I can be less watchful of those trades and yet still watch my P&L grow weekly. Following will be examples from the four previous weeks of premium selling and the strategy I used to implement my trades (I am skipping the first week of November because the storm prevented me from implementing the  the trade that week). Keep in mind that NOTHING is 100% consistent when it comes to trading. I would like to assume that anyone who has ever traded before already knows that, but I wanted to state it because at some point there will be an exception and the strategy will fail one week.

Since my main goal using this strategy is consistent income, I try to make fairly safe trades. I have found that AAPL is able to provide me with that safety. That may surprise you when you think about the recent movement in AAPL, not to mention that it is on everyone’s radar; however, I think that is what makes the stock such a good vehicle for premium sellers.  The trade I will demonstrate is to sell a weekly call spread. I wait till Wednesday morning or afternoon after the option has had 4 days to trade (Thursday, Friday, Monday & Tuesday – of course this just recently changed – see below for details) and I begin to look at the open interest. Based on the highest call open interest or one of the highest near Tuesday’s closing price, I place my trade. The reason I prefer call spreads to put spreads is that AAPL always has  more bulls than bears and more call buyers than put buyers. Some of you may thinking, well perhaps it worked the four weeks you are demonstrating because AAPL has been in such a downtrend; however, this strategy almost always works even when AAPL is on an uptrend (excluding weeks with events that I typically don’t trade) Perhaps one day this will change and therefore my strategy will change, but even with the most recent sell off, there are still more bulls than bears. I also will need to pay attention to any changes that might be brought about due to the new way weekly options will be available five weeks in advance (see here for an explanation of the changes). Here are the four previous weeks of trades…

Monthly option expiring 10/19
Here is what the open interest looked like on Wednesday morning 10/17

Because this was a monthly expiration I used the highest open call interest closest to the closing price on Tuesday, which was at the 650 strike. I bought the 665 call and sold the 655 call. The reason I didn’t choose 650 is that I am trying to play the safer trade. The closing price on Friday 10/19 was 609.84 and therefore both options expired worthless and I got to keep the credit I took in from the 655 call minus the price I paid for the 665 call.

Weekly option expiring 10/26
Here is what the open interest looked like on Wednesday morning 10/24 

I don’t usually play earnings week like I mentioned, but I decided to give this one a try and take advantage of the extra implied volatility. I used the highest open interest at 670, which had over 8,000 open call options. I felt I was leaving plenty of room for a surprise beat since AAPL closed at 616.83 on Tuesday. I sold the 675 strike and bought the 685 strike. The stock closed on Friday 10/26 (the day after earnings) at 604.00 and I kept the credit I took in.
Weekly option expiring 11/9
Here is what the open interest looked like on Wednesday morning 11/07

Because the highest open interest was so far from Tuesday’s closing price, I instead used the 570 strike (which had about 8000 open call options) to determine my trade. I sold the 575 call and bought the 585 call. The price closed Friday 11/9 at 547.06 and I took in all the credit from the spread.

Monthly option expiring 11/16
Here is what the open interest looked like on Wednesday morning 11/14 Again, because this was a monthly I didn’t use the highest open interest, which was over 150 points from where Tuesday’s closing price was. I instead used the 550 call strike which had almost 15,000 open contracts. I sold the 555 and bought the 560 call strike. AAPL closed Friday 11/16 at 527.68 and I kept the credit I took in from the spread.

So once again, thanks institutions! If you are looking to implement this type of trade keep in mind that the new system of having AAPL weeklies made more available further in advance could change things. I may start looking into calendar spreads with this new system in place and if I find a system I like, I will write about it.

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  1. I’m guessing that the brokerage is holding a good deal of margin on you because these are credit spreads.