Vertical credit spreads are a popular options trading strategy that allows traders to profit from time decay and limited risk. When implementing this strategy, one crucial decision is selecting the expiration date for the options involved. Choosing the appropriate expiration date requires careful consideration of various factors, including the trader’s objectives, market conditions, and risk tolerance.

Selecting The Right Expiration

1. Define Your Trading Objectives: Before selecting an expiration date, it is essential to determine your trading objectives. Are you aiming for short-term gains or looking for longer-term positions? Are you seeking rapid income or employing a more conservative approach? Clearly defining your goals will help guide your decision-making process.
2. Time Decay: Time decay, also known as theta decay, is a critical factor in vertical credit spreads. As an options seller, you want the value of the options you sold to decrease over time, leading to a profit. The closer the expiration date, the faster the time decay accelerates. Shorter expiration dates generally offer more rapid time decay, making them suitable for traders seeking quicker profits.
3. Market Outlook: Consider your overall outlook for the underlying security or market. Are you bullish, bearish, or neutral? Different expiration dates can help align your spread with your market outlook. For instance, if you are bullish, you may opt for a longer expiration date to allow more time for the underlying asset to move in your favor. Conversely, if you expect a quick price movement, a shorter expiration date may be more suitable.
4. Event Risk: Events such as earnings announcements, economic data releases, or geopolitical developments can significantly impact the price of the underlying asset. It is crucial to be aware of any upcoming events that may influence your spread. If there are significant events on the horizon, you might consider selecting an expiration date that falls after the event to minimize the risk of sudden price swings.
5. Liquidity: Liquidity is an important consideration when trading options. Higher liquidity ensures tighter bid-ask spreads and smoother trade executions. Expiration dates with higher trading volumes and open interest tend to offer better liquidity. This can be advantageous, especially when managing or closing positions. Opt for expiration dates with sufficient liquidity to avoid potential difficulties when entering or exiting trades.
6. Risk Tolerance: Each trader has a different risk tolerance level. Shorter expiration dates often offer higher potential returns but come with increased risk. Longer expiration dates allow for more time to manage and adjust positions, potentially reducing risk. Assess your risk tolerance and choose an expiration date that aligns with your comfort level.
7. Historical Price Volatility: Analyze the historical volatility of the underlying asset to gain insight into its potential price movements. If the security has experienced significant price swings in the past, it might be prudent to select a longer expiration date to account for potential future fluctuations. Conversely, low-volatility securities may be better suited for shorter expiration dates.

Which Expiration I Pick

After running numerous backtests and trading credit spreads with my Inner Circle Credit Spreads program, I have found the perfect expiration date for me. If you are following the trending (selling put credit spreads during bullish markets), then the ideal expiration is 14 days then rounding to the next Friday. So for example, let’s say it’s May 12. The expiration I would target would be (12+14 = 16 then round to the next Friday) May 19th. You can learn more about the backtests and why this is the ideal strike price here.

Selecting the right expiration date is a crucial aspect of successful vertical credit spread trading. Consider your trading objectives, time decay, market outlook, event risks, liquidity, risk tolerance, and historical price volatility when making this decision. By evaluating these factors, you can increase your chances of optimizing your vertical credit spread strategy and achieving your desired trading outcomes. Remember, practice and experience will further refine your ability to select expiration dates effectively.

Thanks for reading 🙂
Austin Bouley
CEO & Chief Strategy Officer