Have you ever heard of the quote, “Picking up pennies in front of a steam roller”? This is a quote that is thrown around a lot in the Credit Spreads trading world. This is because you can easily have a higher win rate by going further out. However, the further you go out, the less money you make which means you lose a lot when you do. I want to talk about this topic and how much credit you need to collect based on your win rate.

“Picking Up Pennies In Front A Steam Roller”

The absolute easiest way to increase your win rate when trading credit spreads is by going further out (strike wise). If you pick a 30 delta credit spread, you can collect around .30 per spread with a 70% win rate. If you pick a 10 delta, you increase your win rate to roughly 90% but will collect around .10 per spread.

This is the idea of picking up “pennies” because you are collecting such a small amount. Because of the way credit spreads trades are set up, the less credit you collect, the larger your max loss. This means when you loss, you will get by a “steam roller.” This is typically something said by people who don’t understand long term expectancy.

Long Term Expectancy

Before I dive into the win rate and credit collection required, you need to understand long term expectancy. Long term expectancy is a mathematical calculation to show you what return you can expect based on win rate, win size and loss size.

Long term expectancy = ( Win Rate Percentage x Win Size ) – ( ( 1 – Win Rate Percentage) x Loss Size)

For example, you have a strategy with an average win rate of 85%, an average winner of $30 and average loser of $10.

Long term expectancy = ( .85 x $30 ) – ( (1 – .85) x $10 ) = 25.5 – 1.5 = 24.

Since the long term expectancy is a large positive number, you can expect to make money with this strategy long term, given the numbers stay the same.

Win Rate And Credit Collection Required

** Assumes a $1 width credit spread **

The chart above shows how much credit you need to collected based on your win rate and what long term expectancy you want. A long term expectancy of 0 means that you breakeven, so factoring in commissions, you want to take a 5 to 10 long term expectancy.

This should be a helpful guide when trading or creating credit spreads strategies. Because if you can’t collect the minimum credit for a positive long term expectancy, then long term, your strategy won’t yield profitable results.

With the strategies that I use for my own trading and for the Inner Circle Alerts Members, we have an average win rate of 94% and collect on average .15 per spread. That puts us at a long term expectancy of above 5 based on the chart above.

I hope you found this article helpful and use it when evaluating trades and strategies!

Thanks for reading 🙂
Austin Bouley
CEO & Chief Strategy Officer