Looking for a stable way to generate market income while minimizing drawdown? Then you might want to employ a credit spread strategy. However, picking the right stocks can be challenging due to the complexity of options pricing and the ins and outs of credit spread strategies. Not to worry, we’ve done the work for you below.
Best Stocks For Credit Spreads
Salesforce Inc (NYSE: CRM)
CRM is a leading provider of cloud-based software for sales teams and customer relationship management.
Its software ranks number one worldwide regarding CRM solutions, as its customer base exceeds 150,000 clients.
But as impressive as that all sounds we are not here for the performance flex. Instead, we are here to examine how or why this stock could be an ideal candidate for a credit spread.
For one thing, Salesforce has been making rounds in options screeners due to its increased implied volatility (IV).
Implied volatility is a metric used in the pricing algorithm of options contracts. It represents a stock’s expected volatility over the option’s life.
A high IV—or juice as commonly known—can lead to higher option premiums and vice versa.
If you are confused about what I just said, you are probably not alone. Options pricing can be complex and confusing for most, as options contracts pricing dynamics dive deeper than price action.
For example, the price of an underlying security could rise, while the value of its call option could run in the opposite direction. This could, among many things, be due to a drain of the options contract IV.
Occurrences like this tend to happen seen during periods of high volume and high demand.
For example, during earnings season, during periods of high market volatility, or when there is important news surrounding the stock.
In other words, if the market expects a big move or substantial stock price change, it’s likely to have higher implied volatility.
This complex yet efficient options pricing algorithm was developed in 1973 by Fischer Black, Myron Scholes, and Robert Merton.
Their formula eventually led to advancements in the development of quantitative finance and earned them a Novel Prize in economic sciences.
I say this to help you grasp the complexity of the underlying determining factor that goes into pricing options. It’s critical to have at least a good understanding of options pricing dynamics if one wishes to succeed with credit spread strategies.
But what’s most important is to understand how IV affects the strategy. Simply put, a stock with a high IV could be a suitable candidate for certain credit spread strategies.
For example, CRM option contracts with high IV could be ripe for short volatility credit spreads. Some of these include an iron condor, a short straddle, or strangle.
Nike Inc (NYSE: NKE)
Nike is a global leader in sports apparel, including its iconic athletic footwear. The brand is among the most recognized globally, distributing its products in 170 countries.
Nike is another stock whose options contracts have been juiced up with IV lately.
The company’s liquidity and large market capitalization make it an ideal candidate for a credit spread strategy.
Given the high IV, Nike option contracts could benefit from a short volatility credit spread strategy.
Usually, short volatility spreads work better than a bull put spread or a bear call spread in this scenario.
The company is also quite large and well-established, which provides great liquidity in its option contracts.
High liquidity in options contracts not only makes credit spread strategies easier to execute. But it also provides tight spreads, which reduce the cost of trading.
For example, let’s examine Nike’s monthly contracts. The near-the-money contracts might only show a difference between $0.05 and $0.20 per share between the bid and the ask.
Because options contracts represent 100 shares of a company.
Therefore, $0.05 and $0.20 range between $5 and $20 per contract. A spread wider than $0.20 could start you off on the wrong foot.
Apple Inc (NASDAQ: AAPL)
Apple is the largest company in the world by market capitalization and a titan in the world of technology.
Its best-selling product, the iPhone, is estimated to be used by over 1 billion people worldwide.
Shares of the company have been consolidating since 2021 following a market slowdown.
Stocks that trend on a range could work well when looking to employ certain credit spread strategies.
These might include a short iron condor, a bull put spread, a bear call spread, or a short strangle.
Strategies like these could work well with a ranging stock because they are designed to profit from sideways market movements.
Generally speaking, AAPL is an excellent optionable stock. The company’s option contracts are highly liquid and have tight spreads, lowering the difference between the bid and the ask.
For example, the spread in both monthly and weekly options contracts for this stock could range between $0.01 and $0.30.
Amazon.com, Inc. (NASDAQ: AMZN)
Jeff Bezos’ pride and joy is also one of the world’s largest online retailers servicing customers all around the globe.
But the 6th most visited website in the United States does much more than that. Its business spans numerous segments, including Amazon Web Services, Amazon Prime, Amazon Fresh, and more.
Like AAPL, this stock tends to be a great one for option strategies.
Amazon is particularly known for its volatility. But more importantly for the way its contracts premium are juiced when volatility increases.
This increased volatility could result in a larger credit received when selling a credit spread. Thus making it an excellent contender for the strategy.
Amazon option contracts are also well known for having tight spreads between the bid and the ask.
The difference between the bid and ask in most weekly and monthly contracts tends to be between $0.01 and $0.15.
However, some risks are involved with Amazon, like the possibility of it being subject to large price swings. These price swings could pose risks for a credit spread strategy.
Oracle Corporation (NYSE: ORCL)
Oracle is a tech company that specializes in database software and cloud computing. ORCL is one of the largest software companies in the world, boasting a market cap of nearly $200 billion.
Oracle trades a little bit differently than other tech stocks in that it tends to have lower volatility.
Consequently, option premiums may be lower, but the risk of large price swings may also be reduced.
But as of late, this company’s options have also been making rounds in the IV scanners. Showing a change in the tide could just be what investors need to employ a credit spread strategy.
Like CRM, this company could benefit from short volatility credit spreads like an iron condor, a short straddle, or strangles.
Aside from this, shares of Oracle have been trading in a tight range since the beginning of January 2023.
This tight-range price action could provide the right conditions for a Theta drain in the options contracts. Thus, making it an ideal candidate for a credit spreads strategy.
The spread and the bid difference in the monthly Oracle options contracts also happen to be quite tight. It oscillates between $0.10 and $0.20 per contract.
Are Stocks For Credit Spreads a Good Investment?
Credit spreads can be a great way to limit your risk while seeking to generate income with an options strategy.
However, the strategy might be better suited for seasoned traders that understand the ins and outs of credit spread strategies and options pricing.
But there could be a pot of gold at the end of the rainbow for investors that can master the complexities that come with credit spreads.
A credit spread involves the selling and buying of in-the-money call or put option contracts with the same expiration date. However, the contracts differ in strike prices.
As a result, the investor could benefit from the net premium received. This strategy leverages the option’s time decay (or the Theta value) from an options pricing algorithm to generate profits.
In simpler terms, they can be a great way to gain exposure to underlying security even if the price of the stock trades flat.
In fact, it doesn’t matter if the price goes up, down, or sideways. What’s important is that it doesn’t go below the options strike price by the time the contract expires.
Because of this, credit spreads have a much lower breakeven price. Thus, they tend to have a higher win rate than call options, put options, or debit spreads.
Another benefit of utilizing this income-generating options strategy is that it could work well despite the stock market conditions.
In other words, it’s an all-terrain strategy that could earn you a living even when things aren’t going so well.
Credit spread can also limit your potential drawdown when comparing them to buying or selling stocks or options.
Largely because the strategy creates a limited risk and reward profile and a maximum loss.
However, that doesn’t mean that credit spreads are risk-free; you could still lose money. If the underlying stock moves in the wrong direction, the investment might end up at a loss.
Notably, these strategies can also be complex as are the underlying factors that go into options contracts and their pricing algorithms.
Therefore, credit spreads might be best left out for seasoned traders and investors.
Best Stocks for Credit Spreads FAQs
How Do I Find the Best Stock for Credit Spreads?
The best way to find the stocks for credit spreads is to use a stock scanner. In it, you can categorize your search by filtering attributes that make a stock a good candidate for a credit spread. These might include high IV, high volume, and high open interest.
What Stocks Are Best for Credit Spreads?
The best stocks for credit spreads are the ones whose options contracts have suitable attributes for the strategy. These include stocks with large market capitalization and a high average trading volume. You might also want to check the bid/ask spread, open interest, and implied volatility.
Are Credit Spreads Profitable?
Credit spreads could be profitable when they are executed properly. This option trading strategy is known to be more forgiving. It also has a higher probability of winning than buying a call, put, or debit spread. However, as with all investments, there is never a certain outcome.
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