Quote from flyers&divers:
I disagree with people who think you are diversified too much and there are some comments from people who do not understand the essence of credit spread trading.
They are legions of people who believe that trading is a zero expectancy game and in this case the $1.50 reward for $5 risk is not high enough.
First, in a credit spread trade you are dealing with out of the money options and time decay is also in your favor. In addition
even the use of the simplest TA such as volatility bands and MA's increases positive expectancy of the trade and you can use all kinds of other info as well like ZAKS and S&P ratings, seasonals, sentiment, special events etc. and you are no longer shooting fish in a barrel like it is assumed in these conversations.
People don't realize or I have not seen it mentioned that there is a different relationship to expectancy here: unlike outright positions credit spreads work most of the time and one's focus is not on cutting one's losses and letting one's profits run but minimizing the effect of the occasional large loss.
Sometimes when the stock moves against the position one can wiggle out of it or adjust or simply take a(complete or partial)loss. The worst case is a takeover or delisting or adverse guidance. In that case you are toast, and this is why it is good to be broadly diversified.
I am a swing trader and along my outright positions I always have opportunistic spreads on for a turn. Recently I had some on in the gaming stocks battered by Katrina, in the poultry and bio stocks playing the Avian Flu theme, I also had put spreads on gold stocks which I just took off and I am starting to put on bearish spreads on the indices because based on my TA and sentiment work the markets may be trading from sideways to lower from here on. Of course, one has to pay attention to TA with these trades too.
Someone could say that in a larger sample of trades the win-loss ratio would stay constant therefore diversifying further is not productive, I say that the occasional large losses would be likely spread out in a larger sample so it would still help smoothing the equity curve.
The truth is, and most people are not willing to face this (even people in the business), that you should not trade at all until you figured out a method or technique that gives you and edge and beyond that you need to manage yourself and trades well to be successful. Still, the possibility of surviving trading spreads is enhanced by the the benefit of time decay.
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