Income Through Vertical Spreads

I agree with many of the arguments for and against this strategy.
I have been really successful with credit spreads and condors, BUT, I waited until I knew more about price action, volatility, etc. and I only traded the indexes.
I prefer the NDX, OEX, SOX, and SPX.
Trading is not a one size fits all type of system.
Some people are fantastic day traders, others, like myself, suck.
I am more of a swing trader myself and that suits me fine.
I have a friend who manages a few funds and is very successful with credit spreads and calendar spreads, BUT he has a system he follows and uses large amounts of capital to be way OTM and only looks for 3% per side in any spread, and may chase it or set the opposing spread to make the difference.
Any system takes time and lots of patience.
Yes, you will lose money, it's the price of the education,.........ignorance can be more expensive.
 
1) Are selling vertical spreads a viable way to produce monthly income over the long term? I generally look for 8-10% return a month but am happy with anything over 5%. Basically, I am selling time decay. I have been successful but I want to ensure it’s not a fluke.

Your success will depend on your timing, selection and money management. There is no inherent edge in any strategy.


2) Do most people who sell the spreads close them out before expiration? For the first time my short call is getting closer to being in the money then in my past. If you do, is there a rule of thumb you use (i.e. sell them the week before expiration?)

"If" the ideal time to close verticals was 3 days before expiration and while waiting until then, 5 days before expiration the underlying reversed big time, taking away all of your profit and perhaps incurring a loss, would you care that on average, 3 days is best? If trading directionally, you close positions when you believe it's moving against you. Time is your friend, reversals are not.


3) Is there an industry average risk to return ratio for the spreads? I know everyone trades differently but if I am collecting 0.45 on a 5 point spread, I stand to loose a good amount. But I also only will enter the trade if there is a 75% chance that the short call will not end in the money.

Are you the average? I think you answered that.
 
Quote from uptickk:

If I were to only base my trades off of being 75% profitable and never made any adjustments then I would agree with the above, however, I have the ability to use technical analysis (moving average, resistance, support, etc.) (got to be worth something right?) for direction, additionally I can close out a position well before I would hit my max loss of $4.50. If this is all true then I would think that I would be able to move the expected return in my favor. Am I thinking logically here or have I just convinced myself that my strategy will work?

I guess what I am getting at here is that I know my risk/reward ratio isn’t anywhere near the yahoo screeners show but if my trades have a higher probably on their own and then I add in stops and technical analysis, am I not improving the probably more so.

Thanks once again
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The odds may seem with you but they are not. Say you can improve that win/loss ratio from 75/25 to 90/10 using your technical analysis. This would be extremely difficult but lets say hypothetically you could do it. Say you would still win the $.45 90% of the time and lose $4.50 10% of the time. You would still lose money. If you were to do a hundred trades winning 45 cents 90% of the time and losing $4.5 10% then you would lose $4.50.

You could not thwart this with stops. Some of your winning trades will turn into losers by the miracle of time decay and whipsaws. You could just as easily want to cut winners short before they reach $.45.

Bottom line is vertical spreads are no way to produce income. It is an option strategy that should be combined with others in your investing or trading strategy. You need to learn all, or nearly all options strategies, imo. You will find situations where a different strategy may be much better than a vertical spread or covered call in certain situations.
 
1) The odds may seem with you but they are not. Say you can improve that win/loss ratio from 75/25 to 90/10 using your technical analysis. This would be extremely difficult but lets say hypothetically you could do it. Say you would still win the $.45 90% of the time and lose $4.50 10% of the time. You would still lose money. If you were to do a hundred trades winning 45 cents 90% of the time and losing $4.5 10% then you would lose $4.50.

This would be true if all of the spreads went to the maximum gain/loss but they're not going to. As the OP indicated, "I can close out a position well before I would hit my max loss of $4.50". Other than the unusual gap up, he's going to have plenty of warning before the underlying goes ITM and that will be long before the maximum loss is reached.


2) You could not thwart this with stops. Some of your winning trades will turn into losers by the miracle of time decay and whipsaws. You could just as easily want to cut winners short before they reach $.45.

The OP is writing OTM credit verticals. Time decay is his friend.


3) Bottom line is vertical spreads are no way to produce income. It is an option strategy that should be combined with others in your investing or trading strategy.

What option strategies are for producing income?
 
Income or net capital gains, what is the difference?? I have done some credit spreads in a demo account and i won because I got the direction right.

The chance to gain 45 cents against the chance to lose 4.50, please help me, but I am having a hard time embracing the concept that that is good. Perhaps it is a better way to acquire stock that cash secured puts, or naked puts.

Perhaps the chance of winning a dollar against the possibility of losing 2.50 makes more sense, but don;t you still have to get teh direction right??
 
Quote from Tom1am:

The chance to gain 45 cents against the chance to lose 4.50, please help me, but I am having a hard time embracing the concept that that is good. Perhaps it is a better way to acquire stock that cash secured puts, or naked puts.
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Is doing an ATM spread for a chance to gain $2.50 against the possibility of losing $2.50 a better choice? Right from the get go you make or lose 50 delta on the underlying.

Or how about the possibility of an ITM spread of making $4.50 versus losing only 50 cents if wrong? One small detail... the ITM spread is 15 pts ITM so you need a BIG move to nab the $4.50

I'm not suggesting that any one of them is best. But you can't look at the maximum R/R ratio in isolation. The amount that the spread is ITM or OTM is also a factor.

If your timing, selection and money management is very good, then your postions should absolutely be ATM to ITM. If not, then more OTM ... or even OOTM (out of the market!)
 
I don't know if you recall, but I started out with short put verticals

That was really my first post here.


I learned very quickly, it's not as easy as it seems, it needs to be watched, and the reward didn't justify the risk (especially w/the commissions I was charged).

At the risk of being assigned, I also tend to close the position a little early, reducing my reward.

In the end, I preferred to be long verticals. Ironically it's less stressful for me, and I just feel like I had more control.

The potential gain is larger as well.
 
Lot of good comments here. Personally, I used to sell verticals a lot, although almost always put spreads. It's not a bad strategy, but as others have said, it's a directional strategy. That means your success will depend almost entirely upon your trading ability. The strategy itself does not confer an edge.

In fact, the strategy is a tradeoff. Any directional stretgy will be more efficient if done using the underlying. In other words, if you think a stock will go up, buy it, don't sell a put vertical. The vertical does give you a defined max loss, plus you profit from a sideways market, but your profit is severely limited. The main reason I stopped using verticals as my main strategy is that the transaction costs tend to eat up a lot of your bottom line. Commish has come down a lot, but if you give up the spread coming and going, you have pissed away a significant percentage of your profit. That tends to make you want to expire them, which is not always the best thing to do.

I hate to rain on anyone's parade, but I think the assumed figure of 75% wins is very optimistic. At the same time, every loss does not have to be a max loss. In fact, the whole key to making this work is to avoid the max loss like the plague.
 
Quote from filter_sweep:

Back in the summer of '07 I started selling vertical spreads and condors by following a newsletter that had a really good track record for doing such. Within a few months I had lost about 1/3 of my account due to the expansion in volatility and because the newsletter I was following kept making "adjustments" to positions that I later figured out were just adjustments to keep from saying they closed the position in order to make their track record look better than it really was.
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Variation of an old saying:

Them that can, do.
Them that can't sell newsletters
 
Couple comments:

1. When looking at risk and reward, you also have to consider the underlying probability of success as well. There have been a couple other users that said risking 5 to get 1 is a terrible idea, but that's not the case. It comes down to your expectancy, which is E = p(s)*reward - (1 - p(s))*risk -- or something like that. If on your trades you're having a positive expectancy over time, then you're doing better than 75% of the traders out there.

2. Based off option pricing models, the implied volatility already gives you what the market is expecting in terms of statistical success. Price action (allegedly) resembles brownian motion which means it's a big ass bell curve.

So going long or short a vertical that is ATM will have an implied probability of success of about 50%, because that's how it's modeled. That may not be the case-- and that's where you make your money.

3. You're neglecting the volatility component here. If you don't have an edge in vol you should be trading common not options. So if you're selling verticals that are OTM you are expecting that price will not move as fast as what the options are pricing in-- you're shorting volatility. If that's you're goal, fine. But when vol upticks you lose money on the vega as well as any fast move.

4. Selling verts for income? Possible, but it's more of a trading strategy that has to actively manage trades rather than a sit-on-hands-buy-write-strat.
 
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