Benefits of Index Spread Trading

Benefits of Index Spread Trading

1) Credit spread trading is a simple, safe, and stress-free type of trade that does not require a great deal of monitoring. You just place the trade, collect the credit, and wait for the options premiums to decrease or expire worthless. Minimum time is required to process and track these credit spread trades.

2) You receive the proceeds of each credit spread trade immediately when your order is filled and you keep these proceeds no matter what happens.

3) The credit spread has two primary advantages as an income generating strategy. First, the position benefits from time decay. Since options decay in value with the passage of time, the value of the credit spread will in turn decay over time. By writing a credit spread, you are selling a decaying asset and receiving a credit or a premium up front. If the underlying market remains stable until expiration, the spread expires worthless, allowing you to keep the premium received. In a sense, you profit from the passage of time.

4) The credit spread also allows you to benefit from market movement. If one writes a bullish credit spread using puts, the value of the spread would rapidly decline as the market moves higher. The converse is true for bearish call spreads. With this flexibility you can inject an element of trend following into your trading program to increase your odds of success.

5) Gains on stock index spread trades are considered ITC Section 1256 contracts. This means any gains made in these trades are taxed under a 60/40 rule. This rule states that gains are treated as 60% long-term capital gain income and 40% short-term capital gain income (ordinary income) regardless of how long the investment was held. So when we hold a index spread trade for 30 days (our average holding period), 60% of the profit made from that trade is treated as long-term capital gain income and taxed at 15% or 5%.

6) Trading capital is only used to support margin requirements when trading credit spreads. Most option brokers allow you to invest your trading capital elsewhere to be used as collateral for spread trading. Trading capital can be invested in closed-end funds that pay dividends monthly and are diversified across munis, preferreds, REITs, corporate bonds, floating rate loans, convertible bonds and other fixed instruments. Between the dividend yield and capital appreciation you can earn 7%-10% annually. Most brokers allow you to margin 100% of cash amounts, 90-95% of t-bill amounts and 50% of the stock amounts like closed-end funds.