Credit Spreads- Horrible Risk:Reward?

[tommo]

I am an experienced futures trader but am looking to supplement with options and been looking into credit spreads

Below is the options chain for the Eurostoxx

Im looking at doing a credit spread on the put side.
The 3200 strike has a delta of -21.50 so around my sweet spot in terms of probabilities and offering 19.6 ticks in premium (196 euros credit)

But looking at the strike prices around it, how wide would you typically make a spread? Im thinking of buying the 3100 put which will give me a total of 11 ticks for this credit spread (19.6 ticks for the 3200 strike - 8.7 ticks for the 3100 strike = 11).

So basically I am risking 100 ticks (1000 euros) to make 11 ticks (110 euros) with roughly an 80% chance of winning based on implied vol. That seems like a pretty horrible trade, if i make 100 euros 8 times out of ten and lose up to 1000 euros the other 2 times (on average) im probably break even at best. But more than likely out of pocket. EVen if I had a great market timing edge and got that up to 90-95% win rate im still around break even


I appreciate volatility is very low at the moment. But even so, the probabilities of reaching each strike price are relative. Am i missing something? Does that mean there are no trades to be done here?

Is the edge in how you handle credit spreads going offside.. rolling them, butterflying them etc. Because just on its on, left to expiry based on the numbers i have outlined is a bad strategy

Would really appreciate some clarification

 

[stevegee58]

The reward:risk sounds about right for credit spreads. Delta is a proxy for the probability of expiring in the money. So if you're planning on not managing these credit spreads (i.e. let them all expire) that's your probability.

If you're going to manage the spreads by buying back the short if the underlying moves against you it gets more complicated. For that you need to know the probability of touching rather than the probability of expiring ITM. Probability of touch will be higher.

Check out the epic thread "Conservative Options Trades" for credit spread approaches.

 

[tommo]

Hi Steve,

Thanks a lot for the reply.
Understood that delta is only hypothetical probabilities. I am assuming odds of touching are about 2 * delta.

Most people on here seem to be trading options on stocks so was wondering if the premiums are higher there? Can't imagine why they would be. But if youre looking at roughly a 70-80% win rate (over a long time) you shouldnt be losing more than 2 x your average win. Its perfectly possible to make money with losers bigger than your winners but losses 10x your win is crazy unless you had a 99% win rate.

Thanks for the link to the other thread, will take a look

 

[stevegee58]

You have to take each proposed trade on a case by case basis. Premiums (i.e. implied volatility) can be higher than indexes depending on what's happening with the company.
High IV companies carry higher risk for option sellers but the higher IV also pushes away the 80% probability shorts you'd put on. (Assuming you're positioning the shorts based on probability)
The OP in that thread I referenced uses expectancy to decide taking the trade. That combines the reward:risk with the probability of winning/losing.

 

[tommcginnis]

Two additional thoughts:
1) capital efficiency generally favors shorter legs, *but*
2) longer legs allow you to get further away from the flame, reducing your delta and 2*delta exposure, thus (likely) reducing your costs-of-roll.
3) big difference between holding-to-expire and holding-til-premium-bulk is theta-ed away.

Sorry so short.

 

[stevegee58]

Yup the safest way is to take off the short when you have, say, 80% of the credit. That way you're not sweating blood on expiration day while getting cooked by gamma rays (pun intended).

 

[Sig]

I'd add that right now isn't the best time to evaluate this since skew is pretty flat and uniform. During higher volatility the skew adds all kinds of interesting opportunities to spreads, so you might want to shelve the idea for now and come back to it when conditions change.

 

[quant1]

I agree with Sig here. You typically end up paying up too much for vol on your long leg. This may not be the case in a more skewed environment.

 

[tommo]

If vol is low would it not be better selling further out strike, a month away, and buying your insurance in the near month and rolling that insurance again if needs be near expiry. You could probably reduce your spread for the same amount of premium.

60 days a long time to wait for 15 ticks though!

 

[Handle123]

I am an experienced futures trader but am looking to supplement with options and been looking into credit spreads

Below is the options chain for the Eurostoxx

Im looking at doing a credit spread on the put side.
The 3200 strike has a delta of -21.50 so around my sweet spot in terms of probabilities and offering 19.6 ticks in premium (196 euros credit)

But looking at the strike prices around it, how wide would you typically make a spread? Im thinking of buying the 3100 put which will give me a total of 11 ticks for this credit spread (19.6 ticks for the 3200 strike - 8.7 ticks for the 3100 strike = 11).

So basically I am risking 100 ticks (1000 euros) to make 11 ticks (110 euros) with roughly an 80% chance of winning based on implied vol. That seems like a pretty horrible trade, if i make 100 euros 8 times out of ten and lose up to 1000 euros the other 2 times (on average) im probably break even at best. But more than likely out of pocket. EVen if I had a great market timing edge and got that up to 90-95% win rate im still around break even


I appreciate volatility is very low at the moment. But even so, the probabilities of reaching each strike price are relative. Am i missing something? Does that mean there are no trades to be done here?

Is the edge in how you handle credit spreads going offside.. rolling them, butterflying them etc. Because just on its on, left to expiry based on the numbers i have outlined is a bad strategy

Would really appreciate some clarification

Are you directional when you trade futures? Trade Credit spreads same way, I tried for few years of doing it strictly on the Greeks and couldn't find that sweet spot, but when I had taken trading systems for the underlying and trade credit spreads instead, working like a charm for me, but you do have to figure out a way of when trade not going as expected as a way to get out at breakeven on losing trade.