Is Credit Spread really profitable?

[cmukesh19]

Lately I was working on credit spread strategy and saw many conflicts. The losers are far out-sized, and even with extremely high winning rates, can barely offset losses.

* If we sell .70 delta credit spreads. Assuming 100 width spread, and if we could collect 25% of width as credit, and lot size 100, gives expected value (% prob * return * lot size):

• Winning trades approximately 0.70 * 25.0 * 100.0 = $1750.0
• Loosing trades approximately 0.30 * -100.0 * 100.0 = - $3000.0
• Net is net negative

* I can change delta and go out further, but that will lower credit. I could try more credit, but that will push me towards ATM options. Even if my assumptions are wrong and we can get over 25% of spread width as credit, the overall calculation won’t change much.

* This calculation is based on no management. If we take profit early (and/or cut losses earlier), results could be worse – as the probability of touch is much higher than delta probabilities suggests. The moment we actively manage the positions, we might get knocked off the trades often, and the winners may make even less.

* Assuming that the IV is usually overstated - for indexes etc. IV been quite low and unless we wait long to place our trades, that advantage is minimal (any may work in both direction).

Is there any statistical study which proves that this strategy is profitable long term? If yes, under what scenarios? Any reason media is advertising this as a best strategy ever discovered?

 

[Nobert]

Lately I was working on credit spread strategy and saw many conflicts. The losers are far out-sized, and even with extremely high winning rates, can barely offset losses.

* If we sell .70 delta credit spreads. Assuming 100 width spread, and if we could collect 25% of width as credit, and lot size 100, gives expected value (% prob * return * lot size):

• Winning trades approximately 0.70 * 25.0 * 100.0 = $1750.0
• Loosing trades approximately 0.30 * -100.0 * 100.0 = - $3000.0
• Net is net negative

* I can change delta and go out further, but that will lower credit. I could try more credit, but that will push me towards ATM options. Even if my assumptions are wrong and we can get over 25% of spread width as credit, the overall calculation won’t change much.

* This calculation is based on no management. If we take profit early (and/or cut losses earlier), results could be worse – as the probability of touch is much higher than delta probabilities suggests. The moment we actively manage the positions, we might get knocked off the trades often, and the winners may make even less.

* Assuming that the IV is usually overstated - for indexes etc. IV been quite low and unless we wait long to place our trades, that advantage is minimal (any may work in both direction).

Is there any statistical study which proves that this strategy is profitable long term? If yes, under what scenarios?

I don't know anything about this.

Yet,

Any reason media is advertising this as a best strategy ever discovered?

- they will advertise anything as long as they get paid.

Random add (a part of full piece), to lure in new people, to buy some magical course strategy :

In my home country, they push hard on life insurance mixed with investing.
They perspective, - they have a better deal, both investing and in case they die, jackpot.
Damn thing brought -18% in the last 3 years or so, and clients still walk around with smiles on their faces.

Conclusion, - don't trust the media, when it comes to investing/trading.

 

[smallfil]

Lately I was working on credit spread strategy and saw many conflicts. The losers are far out-sized, and even with extremely high winning rates, can barely offset losses.

* If we sell .70 delta credit spreads. Assuming 100 width spread, and if we could collect 25% of width as credit, and lot size 100, gives expected value (% prob * return * lot size):

• Winning trades approximately 0.70 * 25.0 * 100.0 = $1750.0
• Loosing trades approximately 0.30 * -100.0 * 100.0 = - $3000.0
• Net is net negative

* I can change delta and go out further, but that will lower credit. I could try more credit, but that will push me towards ATM options. Even if my assumptions are wrong and we can get over 25% of spread width as credit, the overall calculation won’t change much.

* This calculation is based on no management. If we take profit early (and/or cut losses earlier), results could be worse – as the probability of touch is much higher than delta probabilities suggests. The moment we actively manage the positions, we might get knocked off the trades often, and the winners may make even less.

* Assuming that the IV is usually overstated - for indexes etc. IV been quite low and unless we wait long to place our trades, that advantage is minimal (any may work in both direction).

Is there any statistical study which proves that this strategy is profitable long term? If yes, under what scenarios? Any reason media is advertising this as a best strategy ever discovered?

As someone who has traded credit spreads before and lost thousands of dollars on it, you cannot pay me enough to trade credit spreads again! Imagine, risking thousands of dollars to make a few hundred dollars? I would rather risk a few hundred dollars to make thousands of dollars trading options directionally. Even if the win rate is lower, it compensates you for the risk you are taking. Now, it is up to you to control your losses. As for IV, I think the importance of IV is overstated. Options even if the values of IV is low, could still move a substantial amount. Options like stocks move on a supply and demand basis. That is what matters more.

 

[BlueWaterSailor]

You have far too many incorrect assumptions (e.g., your concept of delta is backwards, as is your understanding of risk/reward for credit spreads - and you're missing even the most basic risk management techniques such as stops) for anyone to try and help you without first running an entire "intro to options" class. CBOE and lots of other places (e.g., tastytrades.com and optionalpha.com) have good material on options; study the basics, see how others have done spreads, and work some examples. Then, if you still have questions, come back and ask them - but you need to put in enough effort to make your questions worth answering.

I do agree with @Nobert, though: what the "media" advertises (which media? And why would you assume that they can be trusted with your money, or anything else?) has nothing to do with what is of benefit to you.

 

[cmukesh19]

You have far too many incorrect assumptions (e.g., your concept of delta is backwards, as is your understanding of risk/reward for credit spreads - and you're missing even the most basic risk management techniques such as stops) for anyone to try and help you without first running an entire "intro to options" class. CBOE and lots of other places (e.g., tastytrades.com and optionalpha.com) have good material on options; study the basics, see how others have done spreads, and work some examples. Then, if you still have questions, come back and ask them - but you need to put in enough effort to make your questions worth answering.

I do agree with @Nobert, though: what the "media" advertises (which media? And why would you assume that they can be trusted with your money, or anything else?) has nothing to do with what is of benefit to you.

I have a typo in my original post - I meant selling .30 delta (i.e. roughly 70% probability of winning).
I mentioned stops in my post - problem is the moment you introduce stops - the probabilities as stated by delta no longer work. For example a .30 delta strike won't be remain OTM 70% of time at expiry, by may get touched with much higher probability.
(PS - your assumption is not correct, I have quite some experience in options)

 

[ZBZB]

Be behind the steamroller, not in front of it.

 

[marameo]

How much can IV influence a short-dated credit spread? It's gamma sector rather the vega sector. it's all about time decay (open at 40 days to expiration and close 15 days later). You collect time benefit and sell optionality - non linear payoff. This is what the media is advertising. Pretty much similar to sell front month volatitlity futures to collect positive cost of carry. The % on the single trade is sensational. Yet, the % of ruin increases on the long term. There's is a "stop" somewhere waiting for this strategy.

 

[bln]

Options are priced according to statistical probabilities. That would mean if you do not have some sort of edge that tilts the statistical probability in your favor you can not magically extract money out of the options market.

If you just can tilt the probability slightly to 49/51% or better instead of 50/50% you got something.

(I'm just a rookie so don't take my word for it)

 

[marameo]

There is indeed risk premium that can be harvested from the option market; it is a "structural alpha". Compare 30 days ago vix level and sp500 today realized volatility over the last 30 days. That is (variance) risk premium. The idea to collect that premium for ever - despite market regime, is no sense.

One single trade - selling a vertical, looks like a reasonable risk and probability is towards the seller. Repeating that single reasonable trade againg and again will lead to a "stop".

 

[Global OptionsTrades]

• Winning trades approximately 0.70 * 25.0 * 100.0 = $1750.0
• Losing trades approximately 0.30 * -100.0 * 100.0 = - $3000.0
• Winning trades on other side approximately 1.0 * 25.0 * 100.0 = $2500.0
  
• Net is net positive

Haven't considered your numbers, but assuming that you're not operating in one direction covered by another long position, your hypothesis didn't take the other side into account.