Credit spread - deep otm - false sense of security?
- Thread starter Put_Master
- Start date
yeah.. whats the ideology behind using wider strikes? i don't get it.. if the strike spacing is 5 dollars why spread wider? i know there is a good reason but i don't remember or never got it.. is it because if your ten wide you have a bigger range to cover in if the underlying starts trading into your short strike area?
you change a litlte on the calls side because of the skew slope.. whats that mean.. if the slope is steeper on the put side.. meaning that the pricing of otm puts is more expensive then calls per otm strike... you change the ratio based on the slope... i just don't understand how changing the ratio per the slope make sense.. your talking to a fourth grader here i feel like.. thanks for the explainations..
seems to me if the slope isn't as steep on the calls that you would be able to more easily get a 1x2 ratio for a credit... is this right thinkin?
I would just try to put a similar trade on TOS or send me a PM with your email and I can send you an example of a trade with how I like to set up. The risk profile is everything, then stress test with time, price and volatility. Somebody gave a good explanation of why 10 points on calls rather than 20 points. I would look back at that post.
The ideology is to take more credit with a wider strikes but have greater skew risk. The wider the strikes the more you are exposed to the changes to the vol curve.
I believe it was me talking about the slope, not hedgeman. The slope itself does not have effect on the ratio but the change in slope if underlying gaps to a short strike does. E.g. both calls had the same IV when you put on a trade, so the slope was zero. This is very common for otm calls. But when underlying touches the short strike your short call IV will be much higher because the slope turned negative. You need to predict this and have such a ratio that you compensate the lower IV for long calls (with having more long calls).
Re your last question - the ratio you can do for calls depends not only on the slope but also on the time to expiry. You are right, if the slope is not steep (positive slope, meaning otm vols rise) than you can get more longs for each short. But if the slope is negative (otm vols fall) then the steeper the better.
Looks like hedgeman does not fully understand the effect of time-to-expiry and changes in the skew on backspread position. That's why he thinks it's dangerous to hold it in the front month. It is indeed more dangerous but not significantly and not hard to manage.
I think you may be misinterpretting or misunderstanding how I am trading and when I trade. Yes, the way I trade, is avoiding the front month, meaning I will open back ratio trades with around 2 months out or even more sometimes.
I thought I was clear in saying my puts for SEPT 680/660 are mostly closed with 29 days to expiry in my last reply to you without saying that your post is not accurate. I'm not sure if you read that post or if this is something you trade with regularity. This means that the portion of the trade was profitable and not worth hanging on for every last nickel so why risk it.
We all have OUR own ideas on trading and you prefer the front month or trading within 30 days to expiry and that is fine for you. I don't think its safe to do so and that is my opinion. Also, I don't allow the price to get close to my shorts, if you are doing this and trading with days to expiration, you're risking max loss. I prefer not to trade this way but to each his own.
Sorry, I did not mean that you are doing something wrong. Of course everyone has their own style.
What I meant is by closing out your position early you are giving away profits. Unless both options worth a penny which I highly doubt. As you go into expiry you can have more longs for each short, just maintain the ratio. It has similar risk as you have in the back month. In the end of the day all we need is theta and it flourishes in the front month.
Can you give an example of a completed trade with prices you took to open and close position and where the underlying was? Thanks.
Quote from quatron:
Easily. Look the attached this picture (the first nice-looking from google:
Strikes around 3900 have almost the same IV because the curve bends there.
A picture paints a thousand words, but this is still awesome. I'm going to save this for future reference.