Is Credit Spread really profitable?

[MKTrader]

Pretty much all the sayings you hear about them are true:

• Picking up pennies in front of a speeding train
• It works until it doesn't
• One loss cancels out months of gains

The problem with it (and all simple, high-probability, high-risk/low-reward option strategies) is it's addictive. You make profits for a few months and think you're a genius and forget what can happen. And you also imagine yourself making some great adjustment (rolling out, etc.) but the market keeps tanking and making things worse. Ask those who traded them in Feb. or Dec. of 2018 (not to mention real bear markets).

 

[MKTrader]

https://www.reddit.com/r/path%3D%252Fr%252Foptions%252Fcomments%252F90hioq%252F

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

While there is good, basic teaching on such sites, I'm not convinced the TastyTrade/Options Alpha approach (tons of small trades, hopefully most are modest winners, etc.) even beats buy-and-hold unless you take too much risk (trade too big, not diversified with enough trades, etc.). There's a good thread on Options Alpha here (just search for "Options Alpha Reddit" if my link doesn't show up)

This is especially true for smaller retail traders. And it's A LOT MORE work than buying and holding. Also, good luck if you have a day job and you need to close 15-30 trades as the market crashes while you're in a meeting or travelling or something.

 

[Epicurus]

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?

I was doing some testing on vertical credit spreads earlier this year. Typically 6wks to expiry, selling nearest strike to the money then buying next strike away. Correct trades gave me around 50-60% return.

On a loss, what I really liked about them was that they seemed to hold their value for the first 2 or 3 weeks before eroding to expiry. So you sort of get a low cost look at them for a bit and can close out. I seemed to be able to average lower or equal losses to my wins by closing out if my technical view wasn't validated in this time frame.

I considered these (approx) ATM credit spreads a simple bet on whether price would finish above or below the current price in 6wks. As a technical analyst this is a very attractive series of bets. It basically becomes a test of your win rate from a simple TA view, in which I consider I have a positive expectancy.

At this point I haven't done enough trades to reach conclusions, that's on a future project list. But credit Spreads look really promising and anyone with expertise in TA I'd encourage to test these.

If you dont have any edge in selecting trades or when to exit then these are not for you.

 

[ssp729]

Be behind the steamroller, not in front of it.

hahaha we are still seeing this

 

[ssp729]

Don Fishback offers a service of credit spreads that claims good results
https://www.donfishback.com/odds-high-accuracy-monthlys-no-risk/

I´m still deciding with ZBZB if it works

 

[BlueWaterSailor]

While there is good, basic teaching on such sites, I'm not convinced the TastyTrade/Options Alpha approach (tons of small trades, hopefully most are modest winners, etc.) even beats buy-and-hold unless you take too much risk (trade too big, not diversified with enough trades, etc.).

Note that I only recommended the available education, and not anyone's specific approach. On that topic, going with what someone else tells you to do is a close equivalent to following the "advice" from the media... and I've already stated my perspective on that.

 

[BlueWaterSailor]

Pretty much all the sayings you hear about them are true:

• Picking up pennies in front of a speeding train
• It works until it doesn't
• One loss cancels out months of gains

The problem with it (and all simple, high-probability, high-risk/low-reward option strategies) is it's addictive. You make profits for a few months and think you're a genius and forget what can happen. And you also imagine yourself making some great adjustment (rolling out, etc.) but the market keeps tanking and making things worse. Ask those who traded them in Feb. or Dec. of 2018 (not to mention real bear markets).

It's worth noting that this perspective - and essentially all negative perspectives on this topic - are applicable to every single kind of trade, or any other investment decision. All of them involve risk, and none of them guarantee an edge.

I'm not sure why they're being brought up here, as though they were especially applicable to the OP's question.

(Edit: not picking on you, @MKTrader - just noting your post as one example of many that does this.)

 

[BlueWaterSailor]

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)

Your experience is not implicit in your original post; in fact, the number of obvious errors in it (a delta of .70 - never mind that deltas are typically stated as whole numbers, "100 width spread", 25% credit, etc.) strongly imply the direct opposite.

If I'm going to make a trade with a 30% probability of return, I'm looking for a credit of at least 1/3 the spread width; that is, a 33%+ return on my risk. As an example, here's one I could take in SPY right now:

As you can see, the short strike is at a delta of 30, and the credit is well over 33% of the $1-wide spread.

SPY is at a reasonably high IV rank right now, and a significantly high IV% (35.4/68.4), so I have a fairly high chance of IV collapsing while the trade runs. That's the kind of edge I'd be looking for in this type of trade, and the reason that they have a high overall probability of success.

(Incidentally, I would not use stops here - it's a defined-risk trade with a max loss that I find acceptable. But stops can be useful for lots of other trades; it's just another calculation, with PoT being ~2x delta, that can be a useful tool. There's a reason this asset class is called "options"; this, in itself, should provide a very strong clue that there are no pat answers here - only sets of compromises between pros and cons.)

 

[ffs1001]

@cmukesh19 to share my two-pence worth, I post below my experiences of credit spreads from last year alone :

No of trades : 43 (each trade comprised of many lots)
Profitable trades : 31 (72%)
Traded on : 17 different commodities (eg CL, ZM, GC, EUR, SB, etc etc), but no equities
Average days trade held : 36
Average profit across all trades : +6.4%

The key figure for me is the +6.4%. I held on too long onto some 100% losers (KC is terrible for this sort of thing I discovered) but was very happy with the overall result. I then left credit spreads and started trading the underlying futures directly (much faster response times).

Credit spreads are just a tool which are no better or worse than any other options strategy - in the same way that a screwdriver is no better or worse a tool than a spanner in the toolbox of a plumber. It just depends on what the job at hand requires.

Personally, I like them, and I have been doing OK with them.

The key is to be as right as possible about the direction of the underling.

Good luck.

 

[destriero]

You're underwriting disaster insurance. So either be in the underwriting business and receive the multiple that entails, or trade ATM vol. Both can be viable business models, but one has a much higher ROI.