beginner with options trading question

[jimmyjazz]

I like credit spreads because you can make money if the stock doesn't move or it goes your way or even sometimes when it moves against you. A debt spread needs the stock to move a certain direction.

The downside to a credit spread is capping your gain based on the premium received. In other words credit spreads have a higher probability of profit but they don't have as much reward as a debit spread. Its a trade off.

Ummm . . . no? Disregarding the wider bid/ask spread on the typical debit spread, it is identical to the credit spread with the same strike prices & expiry. One downside to credit spreads is the fact that the short leg will go ITM before the long leg, which potentially exposes the seller to assignment w/o an ITM long option to cover.

There is no fundamental difference between the 2 spreads if pricing is equivalent (other than the risk mentioned above). By "equivalent pricing" I mean the debt is equal to the spread minus the credit.

 

[OptionGuru]

I just put on my first debit put vertical spread on MSFT today.

Now from my understanding, am I correct to believe that profit occurs when my short strike price(currently otm) becomes itm?

• Yes ....... And that would be a good time to exit - when the short strike becomes ATM/ITM.
• You also might find it better to just buy the long OTM option only, instead of making it a Debit Spread. The short option can really hold back potential profits.

 

[rick cremer]

I'm learning options through the TOS simulation platform. I sold a call to try and pocket some premium. Overnight, the underlying gapped up breaching the strike price, but not the premium which was 7 or so dollars.

In this situation. Would it be best to just cut losses and buy to close at the higher rate? Or wait it out and see if it doesn't drop a bit before expiration

Second, if this was real world... what's the likelihood that someone would exercise their call considering they've breached strike price but not the breakeven price?

 

[rick cremer]

I have been a user of the ToS platform (live and simulated) for many years. I trade emini S&P 500 options (Symbol ES) credit spreads. That said, your question begs a few more questions, e.g.;

what symbol did you trade
stock, etf, futures
why did you decide on that particular symbol
fundamental and/or technical analysis
what expiration date
how did you you choose expiration date and strike(s) of the call you sold
did you use ToS' Options Hacker (under the scan tab)feature to identify the call you sold
did you use ToS' Analyze tab to look at risk analysis and probabilities
what criteria did you use in your scan(e.g. Probability, Delta, days to exp, Vol)
did you have a stop loss number in mind and did you place that order along with your sell order
do you have a written trading plan and, along with that,
do you have a written trading strategy
did you follow your plan and strategy

When entering a trade i always use the foregoing questions before hitting the send order button. You need to have a plan and, as a part of that plan, a strategy and be able to stick to it.

I recommend that, if you haven't already, read the following books which are a part of my library and which I have found to be useful.

Options Pricing and Volatility (2nd Ed.)
Natenberg

The Complete Guide to Options Selling (3rd Ed.)
Cordier and Gross

Getting Started in Options (8th Ed.)
Thomsett

All About Options (3rd Ed.)
McCafferty

Trading Weekly Options
Rhoads

Options Spread Trading
Rhoads

Vertical Options Spreads
Conrick and Hanson

Options as a Strategic Investment (5th Ed.)
McMillan

The Bible of Options Strategies (2nd Ed.)
Cohen

Trading Psychology 2.0: From Best Practices to Best Processes
Steenbarger

 

[Robert Modd]

They do act alike in terms of directional bias or delta. They act differently in terms of how they are effected by vega or volatility and theta or time decay.

 

[jimmyjazz]

Selling a put to cap some loss. So simple yet didn't think about it! Thanks, Robert!

I just put on my first debit put vertical spread on MSFT today.

Now from my understanding, am I correct to believe that profit occurs when my short strike price(currently otm) becomes itm?

Let's break this down. You're bearish on MSFT? You expect it to drop to something near or below the strike price of your short put at expiration?

You need to read up on the P/L of your spread at expiry WHICH IS A FUNCTION OF YOUR COST. Your cost effects the point at which the trade becomes profitable.

 

[jimmyjazz]

They do act alike in terms of directional bias or delta. They act differently in terms of how they are effected by vega or volatility and theta or time decay.

You said "a debt spread needs the stock to move a certain direction." That's not always true. If I am bullish on a stock and I buy a call debit spread in which both legs are ITM, then I don't need the underlying to rise. I don't even need it to NOT fall. I just need it to not fall so much that it expires below my breakeven point (assuming I am seeking a profit, which is pretty much the point of putting on a trade).

You also said "in other words credit spreads have a higher probability of profit but they don't have as much reward as a debit spread." This is not true. The P/L (or risk:reward) of credit and debit spreads are identical, at least at expiry. There might be minor differences along the way, but not much . . .

 

[Robert Modd]

When referring to OTM spreads with different strike prices. With a debit spread more time is your enemy and more volatility is your friend. With a credit spread more time is your friend and more volatility is your enemy. Purchasing an option outright has similar characteristics as a debit spread. I like selling credit spreads because as time passes and the stock doesn't move its still profitable. IF you sell credit spreads in a high volatility environment you can also profit as volatility falls. I like spreads vs selling naked because they define my risk.

 

[Robert Modd]

You said "a debt spread needs the stock to move a certain direction." That's not always true. If I am bullish on a stock and I buy a call debit spread in which both legs are ITM, then I don't need the underlying to rise. I don't even need it to NOT fall. I just need it to not fall so much that it expires below my breakeven point (assuming I am seeking a profit, which is pretty much the point of putting on a trade).

You also said "in other words credit spreads have a higher probability of profit but they don't have as much reward as a debit spread." This is not true. The P/L (or risk:reward) of credit and debit spreads are identical, at least at expiry. There might be minor differences along the way, but not much . . .

Yes you are correct. I should re phrase that i am referring to OTM spreads, in which the debt and credit spreads would have different strike prices. I think it is easier to learn about spreads when you look at them as being OTM. I would recommend that thought process as a beginner.

 

[jimmyjazz]

With a debit spread more time is your enemy and more volatility is your friend. With a credit spread more time is your friend and more volatility is your enemy. Purchasing an option outright has similar characteristics as a debit spread. I like selling credit spreads because as time passes and the stock doesn't move its still profitable. IF you sell credit spreads in a high volatility environment you can also profit as volatility falls. I like spreads vs selling naked because they define my risk.


Really? Let's take an example, using Greeks from optionsXpress:

SPX bull call (debit) spread (both legs ITM)
Delta = 3.87
Gamma = -0.05
Vega = - 6.38
Theta = 1.52

SPX bull put (credit) spread (both legs OTM)
Delta = 3.48
Gamma = -0.04
Vega = -5.16
Theta = 1.01


I'm sorry, but "time is your enemy" is a false statement, for both spreads. As time goes on, with no change in the underlying or volatility, your profit will grow, because theta is positive. Looking at the individual legs will show you that the only sign difference is in delta, but the net spread delta works out almost the same (and positive, because we are talking about bullish spreads).