Index Option Credit Spreads

T

torontoman

Is my thinking wrong?

Let's say I get a far out of the money bear call credit spread on an index, which expires in 6 weeks to two months time. I try to collect .65.

For example, I get an 1470 1485 SPX credit spread for .65.

As long as I am available to manage my risk, how can I lose? Manage risk means rolling out if the index reaches a certain level or if the short price doubles or triples. Volatilty would be high if this happenned, so I would be able to roll out farther. Black swans would not be an issue as these are CALL credit spreads.

What am I missing here?

Torontoman
 
Quote from torontoman:

Is my thinking wrong?

Let's say I get a far out of the money bear call credit spread on an index, which expires in 6 weeks to two months time. I try to collect .65.

For example, I get an 1470 1485 SPX credit spread for .65.

As long as I am available to manage my risk, how can I lose? Manage risk means rolling out if the index reaches a certain level or if the short price doubles or triples. Volatilty would be high if this happenned, so I would be able to roll out farther. Black swans would not be an issue as these are CALL credit spreads.

What am I missing here?

Torontoman
More...

Everytime you roll when your position goes against you, you lock in losses and increase your risk. Hardly risk free.
 
You're potentially risking a lot in order to make a little. Don't do it. From time to time, you'll have trouble sleeping at night. From time to time, you'll experience big losses that eat up many, many of your small profits.
 
Quote from nazzdack:

You're potentially risking a lot in order to make a little. Don't do it.
More...
But optioncoach is doing it!
And I'm doing it too :) .
Just know your risk and plan your exits/adjustments. It's no better or worse than any other option strategy. There is no proof (that I have come across) that one strategy is superior to any other - it depends entirely on the competence of the user.
db
 
<i>"Black swans would not be an issue as these are CALL credit spreads."</i>

What happens to your OTM bear-call position if the Fed announces an unscheduled interest-rate CUT of 50 basis?

Your +$65 spread goes -$400 against you immediately. Now what? How do you repair that position?

Learn the answers to those questions, and you'll discover much about risk management.

Think this scenario cannot happen? I've traded thru that twice. The first time, a friend of mine had written $10,000 worth of credit on a $240,000 risk otm SPX call-credit spread position with one week left before expiry.

Odds of probability were huge in their favor. The Fed cut rates midmorning, and the position blew up.
 
Quote from nazzdack:

You're potentially risking a lot in order to make a little. Don't do it. From time to time, you'll have trouble sleeping at night. From time to time, you'll experience big losses that eat up many, many of your small profits.
More...

I see people keep bringing up the potential reward to the potential risk ratio. While that is a valid point to consider, no one seems to be taking into account the probability of that.

Much like risk analysis, you have to multiply the probability of event happening to the payoff and compare based on the result.

If there's a 99% chance you'll make $1 but 1% chance of losing $20, then the expectancy goes with taking the $1.00 "risk". Just because the risk/reward ratio is 1:20 doesn't mean it's a losing trade.
 
Quote from austinp:

<i>"Black swans would not be an issue as these are CALL credit spreads."</i>

What happens to your OTM bear-call position if the Fed announces an unscheduled interest-rate CUT of 50 basis?

Your +$65 spread goes -$400 against you immediately. Now what? How do you repair that position?

Learn the answers to those questions, and you'll discover much about risk management.

Think this scenario cannot happen? I've traded thru that twice. The first time, a friend of mine had written $10,000 worth of credit on a $240,000 risk otm SPX call-credit spread position with one week left before expiry.

Odds of probability were huge in their favor. The Fed cut rates midmorning, and the position blew up.
More...
It all comes back again to position sizing and money management. Who in their right mind would risk $240000 in a $250000 account? Otoh if the account has $10 million then risking $240 k is reasonable (2.4% of total account value)).
db
 
Quote from Maverick74:

Everytime you roll when your position goes against you, you lock in losses and increase your risk. Hardly risk free.
More...

My thinking here is that you would roll a higher quantity so that you can make up for the loss. You're rolling because the market moved fast against the position. Therefore, volatility increases. Therefore, I can get many more credit spreads way out-of-the-money because volatility is high....

Or am I an idiot

Torontoman
 
Quote from torontoman:

My thinking here is that you would roll a higher quantity so that you can make up for the loss. You're rolling because the market moved fast against the position. Therefore, volatility increases. Therefore, I can get many more credit spreads way out-of-the-money because volatility is high....
More...
Yes, you can get more further otm credit spreads but your risk will still increase. All you are really doing is opening a new trade to try to make up for losses in an old trade. Listen to Maverick - you lock in a loss and then increase your risk. Why? Because your original credit spread has moved against you, big time. The only way to salvage this is to close out the original spreads (for a large loss, although you seem to want to 'adjust' to pretend it's not a loss) and open up a bunch (more than the original number) of new ones that are further otm (because higher iv) that will give you enough credit to cover the loss on the old ones. You can call it rolling up or whatever you like but you still end up closing the old ones for a big loss and increasing your risk on the new position much more than the original because you now have a bigger position. Then what do you do if the underlying keeps going against you? Roll up into an even bigger position? If you had enough funds to sustain this then eventually you'd be ok since the market won't go up forever. But I suspect you'd long run out of money or margin before that scenario happened.
Best
db
 
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