Quote from cipherscribe:
How so? If you make a decision to trade only cash-secured, then why would your account end up in margin?
Are you suggesting that you need to go on margin to make a decent return? You maybe right there, I'll have to look into that further. So with the one caveat of being assigned, are there any other risks to margin-trading an equal number of put/call credit spreads where my $$ risk is far lower than my reward?
Don't confuse not being charged margin interest with not being on potential margin leverage.
If you are doing credit spreads you are automatically using leverage.
For example, asssume you have a $50,000 in your account.
Lets do credit spreads, using that entire $50,000.
For the purpose of the example, lets make it simple and say you are putting it all on either one $50/45 spread or 10 of them.
It makes no difference, as either way all your cash is used for 5 point gap spreads. Strike of $50.
Suppose your stock drops below 50, and is trading midway between $45 and $50, and your 30 - 40 day contracts have 2 - 3 weeks left in it.
Perhaps you like the stock and your very reasonable price for the stock.
If it remains under $50 can you consider buying the stock if it gets put to you, or do you need to consider closing the trade for a partial loss?
You can initiate 100 contracts with your $50,000.
That means you need to come up with $500,000 if your contracts are put to you, so you can own the stock(s).
That is 10 times your account value.
So you can NOT buy 95% of your stock(s).... which are already under your strike.
Thus you are left with 2 choices. Close the trade as soon as the stock trades inside your spread, to minimize your loss,... or wait and hope for a recovery back above your strike, before the contract expires.
HOWEVER, if you risk waiting for a recovery, and the stock instead drops a mere penny below your $45 strike on exp day, your $50,000 account will be 100% wiped out.... minus any time value remaining and credits earned,.... (unless you used those credits to initiate even more spreads.)
If you are going to sell credit spreads, i suggest closing them down BEFORE the stock gets inside your spread.
Once it's inside, your rate of loss really picks up steam, if you decide to close them now. The deeper it gets, the greater your loss.
And once it hits your lower strike, your money is all gone.
Thus, since it's risky to let your stock get inside your spread, that means the otm safety cushion you think you have, is really just an illusion, as you dare not let the stock touch it, or get inside.
And the more narrow your spread, the more risky the trade, once the stock is inside. Not much of a cushion between your 2 strikes with those 1 - 2 point spreads.
And once the stock drops a mere penny below your 2nd strike, all your money is gone.... minus any credit and time value remaining.
Not that big a deal for the occasional spread trade in your account. But if you put all your money into spreads, as you were talking about doing, you risk a 100% wipe out of your account, or close to it.
A really bad week or two in the market could easily do it.
Even less time if your trades don't have much of an otm cushion.
Bottom line,.... when you initiate your "so-called" cash secured credit spreads, consider how much it would cost you to buy the stocks if it dropped inside your spread.
If you can not afford to buy them, don't wait until the stock gets inside your spread before you close it.
Because once it's inside, you are now closer than you want to be, to being wiped out.
This is assuming you are using all your cash for spreads.
Not that big a deal for the occasional spread on a stock you feel is more volatile than you are comfortable with.
Spreads are actually a reasonable strategy to protect your cash when investing in volatile stocks or when earnings are pending inside your contract date.
But very risky when you invest all or most of your account cash in them.
What started as a cash secured strategy can suddenly put you on margin of 10 times your account value. Since you can NOT be on margin of more than about 3 times your account value, you will NOT actually be on margin. Instead, your broker will simply close the deteriorating trade for you on exp day, and let you suffer your losses.
BTW, the higher the strikes you use, the more "potential" margin you will be on. And thus, the less control and fewer options (choices) you will have to "manage your risk", if/when things go bad.
