Managing Credit Spreads in Optionshouse

S

Skylark

I've been backtesting a credit spread strategy for a while now and its been working well for me. While paper trading it, though, I've discovered that OH doesn't support using stop limit orders for protecting options spread positions. They told me what I should do is simply submit a net debit order at the highest price (greatest loss) I am willing to to buy the spread back at. They said it should stay open until that price is met, but when I try it in paper trading, that net debit order triggers and buys it back right away. They weren't able to really help me anymore than that.

So does anyone else here sell credit spreads through OH?

And to anyone who likes to sell credit spreads, regardless of brokerage, what is your preferred method for protecting your positions?
 
I do not use OH, but if I understand you correctly, you are trying to protect your credit spread by entering a limit order to buy the spread back, at a price higher than the current market price. When you enter a buy limit order above the current market price (you are willing to pay more than what the market believes to be fair value), it will always be filled immediately. For example, say you sold a $5 spread for a credit of $1. This gives you a max gain of $1, max loss of $4. You want to protect yourself against a loss greater than $1. At your stop point then, it would cost $2 to buy back the spread (the $1 credit you received, plus the $1 the price has moved against you). If, immediately upon entering the spread for a credit of $1, you put in a buy limit order for $2, you have entered a price you are willing to pay that is double what the market is asking, so it will be filled instantly.

Which brings us to stop orders. In my opinion, using stops with options is a bad idea. If you use a stop order, you will likely get a terrible fill, and if you use a stop limit you may not get filled at all which defeats the point of a stop. If you feel the need to have something in place to protect your credit spread against a price jump in the underlying, I think a better way is to use some of the credit you received to buy an option as a static hedge (it is not free, but hedging never is). Regardless, monitor your position closely and never enter a credit spread unless you are willing to accept the risk of the maximum loss from a jump in the underlying (it has happened to me several times).
 
You understood correctly, noregrets. Thanks for the insights. For the times in the week that I am not at my desk to watch my positions, I was also thinking about maybe just setting up alerts for if the underlying reaches a certain price point, and try to break away from what I am doing at that point in time to manage it. But I like your hedging recommendation, too.
 
I think using alerts is actually the best way to go, and I would not generally recommend that you hedge a short vertical--I just wanted to present it as an option. (It's too expensive). Just put the spread on in a size that you can tolerate the max loss if it happens.
 
NOregrets,

can you expand on why hedging credit spreads is usually not a good idea.

What would you hedge with??, Just curious, been getting more into options and looking to absorb more info.

thanks

ef
 
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