Market Movements

^{*Weekly Return is calculated as market open of the previous Wednesday, to market close this Tuesday (yesterday); Current Level is Tuesday’s (yesterday’s) close.}

Weekly Rollout

Markets stumbled out of the gate this week after a gut-check downgrade of the U.S. credit rating, shaking investor confidence and sparking a domino effect. Moody’s wasted no time slicing ratings on major banks like JPMorgan, BofA, and Wells Fargo, citing growing systemic risk. The downgrade wasn’t seismic—but it was enough to rattle nerves. The Dow has eked out gains thanks to UnitedHealth flexing its defensive muscle, but underneath the hood, market breadth looked anemic at best.

Big Tech, once the market’s golden child, is showing cracks as traders take profits and questionable stretched valuations. Even Jamie Dimon chimed in—calling out investor complacency and pointing to rising geopolitical and inflationary risks. While the S&P 500 is still trading near its highs, could the underlying strength be dwindling, resting on increasingly narrow support?

“Good-To-Know’s”

POP is a dynamic, probability-based estimate that shifts with market conditions like volatility, time, and price movement. It doesn't guarantee outcomes—just reflects the statistical likelihood of breaking even or better by expiration.

Many traders use delta as a rough proxy for POP (a 30-delta option implies ~70% POP for a seller), but with multi-leg strategies like vertical spreads, the calculation is more complex and based on the breakeven point of the combined position.

It's important to remember that POP doesn’t account for the magnitude of profit or loss, and real-world factors like news events or volatility skew can quickly make probability models less reliable.

Quote(s) I Like

Thought Throttle

What Are They?

A vertical spread is an options strategy that involves buying and selling two options of the same type (either both calls or both puts), with the same expiration date but different strike prices. They can be used to lessen the capital required for the trade, lessen the risk/downside in the trade, allow for more defined risk/reward scenarios, etc.

The two main divisions of vertical spreads are credit spreads and debit spreads. Credit spreads ‘credit’ your account when you enter the trade, meaning you receive a net premium for the trade. Conversely, debit spreads ‘debit’ your account when you enter the trade, meaning you pay the net premium to enter the trade.

To go even further, Credit and Debit spreads can be broken up into whether or not they use calls or puts.

Here is a chart and table that compares the basic types:

Note: In this edition, the assumption and focus is that the spreads are OTM. To analyze ATM and ITM would require a much lengthier analysis than is appropriate for a newsletter. Respond to this email and let us know if you would like these broken down in a future edition.

I know this can be confusing, particularly if this is your first exposure to vertical spreads. For an in-depth and “easy-to-follow” breakdown of a credit spread, check out this recent weekly edition of the newsletter.

Utilization of Vertical Spreads

To show this in action, let’s look at a Bear Call (Credit) Spread setup for WMT.

On May 9th, 2025, a trader entered a Bear Call (Credit) Spread on WMT. This was largely due to the perceived effect tariffs would have on America’s favorite low-cost provider, paired with the heightened IV from the upcoming May 15th earnings announcement. The trader believed that WMT would remain below $103 through the expiration of May 16th.

The following was entered:

• Sell-To-Open (STO): 16 May 2025 $103 Strike Call Option for $.68 premium

• Buy-To-Open (BTO): 16 May 2025 $105 Strike Call Option for $.40 premium

Walmart’s earnings came and went, and the trader proved to be correct. Walmart mentioned its intent to increase prices due to the tariffs. Consequently (or not), WMT did not rise above $103 through and on expiration.

The trader kept the $28 in premium, which is a ~16.3% return on at-risk capital. This highlights how vertical spreads can generate high-percentage returns relative to risk when managed effectively.

However, it's important to note that the $172 at risk could have been entirely lost—and that’s not an uncommon outcome in options trading. Always be aware of the risks involved, proceed with caution, and consider speaking with a financial professional for guidance tailored to your specific situation.

Trade Mechanics

We can also review what a debit spread would look like in action.

Assume a trader is concerned about Goldman Sachs (GS)—maybe because of the downgrade in US credit, or because GS is at a resistance level & Overbought (RSI), or simply, he just doesn’t like their logo. He believes Goldman is going to decrease to ~$585 per share by June 20th (Currently sits at ~$606).

To express this view, the trader could enter a bear put spread by buying the 20 June 2025 $600 strike put for $15.75 and selling the 20 June 2025 $590 strike put for $11.80.

This creates a vertical debit spread with a net cost of $395, which also represents the maximum loss. The maximum potential gain is $605 if GS closes at or below $590 at expiration—yielding a return of approximately 153.2% on the capital at risk.

That said, when you see returns like this, it’s critical to understand that the probability of full profit is low. This type of directional trade relies heavily on accurate price movement within a defined timeframe, which can be difficult to predict.

It also contrasts with the thesis of Theta Throttle, which educates on strategies that lean on time decay (theta) for more consistent, probabilistic outcomes. This example is simply meant to demonstrate how a debit spread can be structured and what kind of risk/reward profile it can offer.

This is for educational purposes only—not a trade recommendation. Remember to always do your own due diligence and consult a financial advisor before making investment decisions.

Theta Tips: Vertical Spreads

Have a Precise Plan

Before entering the trade, you should have a clear grasp of your max loss, max profit, breakeven points, probability of profit (POP; from earlier, remember?), exit plans (both favorable and unfavorable), and key Greeks like Theta and Vega. Precision matters—understanding every aspect of your option strategy ensures you're not leaving anything material in the realm of ignorance.

And that’s just the options side of the equation. It doesn’t even touch on the deeper layer of analysis required for the underlying stock itself—something equally important and often overlooked.

Find Underlyings and Expirations with Good Liquidity

Stocks with higher liquidity tend to have narrower “bid-ask spreads”—which are essentially a fee paid to the market maker to get your trade filled. Without diving too deep into market jargon, the wider the gap between bid and ask, the worse off you (the trader) are.

To avoid this, we focus on liquid stocks (those traded frequently), ensuring there’s enough activity on both sides of the contract for fast, low-cost execution. This becomes even more important when using vertical spreads, since you're dealing with two options. If you're not careful, wide spreads can quietly eat into your potential profit.

Best to use the advantage of liquidity and stick to narrow bid-ask spreads.

Pin Risk: What Is It and How to Avoid It

Pin risk arises when a stock closes between the strike prices of your vertical spread at expiration. For instance, in a $150/$155 vertical spread, if the stock closes at $154.95 on expiration, here’s what can happen:

• Your short leg may be assigned.

• Your long leg might not be automatically exercised.

• This creates unexpected stock exposure—either long or short—over the weekend.

To reduce the chances of this happening:

• Close spreads before expiration if the stock is trading near your short strike.

• Monitor near-the-money spreads closely in the final hour or two before expiration.

• Understand the assignment and exercise rules of your broker and the OCC.

Pin risk is rare but real—and if you're not careful, it can turn a well-managed trade into a surprise position come Monday morning.

Final Thoughts

Vertical spreads are a natural next step for traders looking to evolve beyond covered calls and cash-secured puts. They offer defined risk, flexible directional plays, and efficient use of capital—especially in environments with elevated volatility or uncertainty. Whether structured as debit or credit spreads, they allow traders to express a view with limited downside and more strategic control.

But while vertical spreads can enhance returns and reduce capital requirements, they come with important trade-offs. Unlike strategies like CSPs—where assignment can be a neutral or even welcome outcome—vertical spreads are a zero-sum game: you’re either right or wrong, and there’s no middle ground. They also often require higher trading costs (two legs = double the commissions/slippage), and may demand elevated trading permissions or margin levels, depending on your broker.

As always, the most powerful strategy is understanding what you're trading. Know your risks, know your mechanics, and don’t chase setups you don’t fully understand. Options are a tool—not a shortcut. Trade smart, manage risk, and always be learning.

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Disclaimer

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