Methodology of the DITM Vertical Bull Call Spread
- Thread starter yucca_mtn
- Start date
reply to KS
covered calls in the strategy of owning a stock or ETF long, and then selling calls against it. It's used as a hedge and to hopefully generate extra yield.
Example: you own 100 shares of ABC stock, present price is $35.
You might sell a call several months away - say a strike price of 40. You might get $250 for the option. Several months down the road, the option is about to expire and the stock is at $39. Well you made $400 gain in the stock plus $250 gain because the option you sold will expire useless.
The comment about this being roughly equal to a bull call spread is something I disagree with. The stock can decline a large percentage, and the call only protects $250 of that loss.
The spread is more of a limited loss, limited gain thing.
covered calls in the strategy of owning a stock or ETF long, and then selling calls against it. It's used as a hedge and to hopefully generate extra yield.
Example: you own 100 shares of ABC stock, present price is $35.
You might sell a call several months away - say a strike price of 40. You might get $250 for the option. Several months down the road, the option is about to expire and the stock is at $39. Well you made $400 gain in the stock plus $250 gain because the option you sold will expire useless.
The comment about this being roughly equal to a bull call spread is something I disagree with. The stock can decline a large percentage, and the call only protects $250 of that loss.
The spread is more of a limited loss, limited gain thing.
One more thing before the Game.
Discussing the pro and cons of call spreads and put spreads is one thing, but they both share many characteristics.
A strategy is just a strategy. The implementation or methodology is what makes it work or not.
Does anyone disagree that a DITM Vertical Bull spread (consisting of puts or calls or whatever) is the safest trading strategy that allows for a good yield? When the outlook for the sector of interest or the market in general is good or neutral, what is better?
For example, I'm not putting on many new positions right now, because I want to watch the market for awhile.
There is so much to discuss about the advantages of this spread.
How it behaves as the prices change for example. When prices go up you positions get safer - you don't make anymore money, you just get safer.
Discussing the pro and cons of call spreads and put spreads is one thing, but they both share many characteristics.
A strategy is just a strategy. The implementation or methodology is what makes it work or not.
Does anyone disagree that a DITM Vertical Bull spread (consisting of puts or calls or whatever) is the safest trading strategy that allows for a good yield? When the outlook for the sector of interest or the market in general is good or neutral, what is better?
For example, I'm not putting on many new positions right now, because I want to watch the market for awhile.
There is so much to discuss about the advantages of this spread.
How it behaves as the prices change for example. When prices go up you positions get safer - you don't make anymore money, you just get safer.
yucca:
Interesting topic...
How do you make decent money out of DITM vertical spread? From my experience trading front month vertical spreads, the "safer" and more "ITM' the spread gets, the less max profit you make at expiration, e.g. 0.5 or less max profit out of a 5 pt spread. How wide a spread do you use on your positions?
Thanks!
Interesting topic...
How do you make decent money out of DITM vertical spread? From my experience trading front month vertical spreads, the "safer" and more "ITM' the spread gets, the less max profit you make at expiration, e.g. 0.5 or less max profit out of a 5 pt spread. How wide a spread do you use on your positions?
Thanks!
I think the reason this type of spread has not gotten more attention is that it was not practical until the Deep Discount Brokers started offering option contracts for $.75. You canât pay $4 for a $5 spread if commissions are going to take a big chunk out of that $1 profit. But paying a $1.5 for a yield of $100 is a heck of a bargin.
When I started this thread to discuss the DITM Bull Cal spread, I had contentions to air, and I had goals to resolve.
My contention is that this is an excellent strategy for novice traders who are willing to learn about the benefits and challenges before they jump into it. Now I will state some of the reasons I hold that contention.
The skills needed to manage these positions are based on common sensible, logical, easily understandable concepts. There is no need for years of study of option theory to do this. There is no need to understand âvolatility playsâ, âdelta neutralâ, gamma, theta, etc. These things will not earn you one more nickel than I will make without that knowledge.
The spreads themselves are logical and easily understood when someone explains them is understandable ways to novices.
I donât think any novices will benefit from the few messages already in this thread. They donât care about liquidity, synthetics, puts vs. calls. They want it kept simple and understandable, and practical.
They want the prospect of high yield without the need for constant monitoring. They have jobs and are not interested in exotic trades, scalping, forexs, and futures. Lets keep it simple. Let beginners start trading a simple strategy and grow into fancy stuff if they want to. Sticking to vertical spreads tends to minimize all that stuff anyway.
Learning how to do the trades and what they are is the price of admission to this club, but that is the EASY part. Learning the terminology is easy. Learning how to operate a trading platform like InteractiveBrokerâs is challenging, but this is still the EASY part.
The hard part is what follows, but the hard part is still common sense.
My goals are to discuss the issues that are challenging in using these spreads and determining what are the BEST solutions to these challenges.
Here are the big challenges:
1. Stock selection and market timing. Everybody who invests or trades has these problems. But the techniques used by participants in this strategy are vastly different from those used by day-traders, long term investors, and by those who use a thousand other spread strategies different than this one. Bull spreads donât work so well when the market is crashing down around our ears. So we donât enter these spreads anticipating that scenario. My contention is we don't have to become stock gurus, we have to become good at picking our sources of information.
2. Position management. What do we do when stocks rise and when they fall? What can we do to reduce risk and losses, and to maximize profits? What is a good exit strategy for this specific type of spread? When is the optimum time to implement these management techniques?
The post by FullyArticulate mentioned that things can go bad very quickly. He is absolutely right. When the shit hits the fan, it happens so fast it takes your breath away! These spreads are leveraged, and they move a lot from day to day. We expect that! We donât depend on luck or prayer, or good luck charms. The only way we withstand that vicious onslaught is to have a LOT of confidence in the prospects of the sectors and stocks we selected, or at least our ability to find the sources of information about them that we trust, and also to have a PLAN for position management to handle the situation. The novice should not be overly fearful about this. You stick your toe in the water and try it out first. You will grow into it.
3. How to properly diversify for safety. What are the consequences of having multiple positions in the same stock but with different strike dates or different strike levels? How does that affect margin requirements?
4. How to anticipate early executions and plan for them. How to anticipate expiration problems and how to avoid them.
5. How much cash do we keep on hand to handle maintenance issues? Rolling spreads? How can we raise cash from our positions when we need to?
There are many more issues that concern traders but they are more general in nature, like money management, margin issues, etc.
So Iâll listen to arguments about what is better bull put spreads or bull call spreads, but honestly I donât have any of the problems you talk about. I can enter and exit the positions just fine (mostly). I can easily find spreads that yield my target of 50% per year profit, assuming I have handled stock selection properly. I donât have a big problem with liquidity issues. I feel I am making optimal use of the funds I have available. If I can grow my portfolio by 40 to 50% anually, I really have no complaints.
I want to learn better techniques for stock selection and sector selection and timing my entries. All the rest is secondary.
If there are interested novices reading this, I still invite you to request a written document from me.
When I started this thread to discuss the DITM Bull Cal spread, I had contentions to air, and I had goals to resolve.
My contention is that this is an excellent strategy for novice traders who are willing to learn about the benefits and challenges before they jump into it. Now I will state some of the reasons I hold that contention.
The skills needed to manage these positions are based on common sensible, logical, easily understandable concepts. There is no need for years of study of option theory to do this. There is no need to understand âvolatility playsâ, âdelta neutralâ, gamma, theta, etc. These things will not earn you one more nickel than I will make without that knowledge.
The spreads themselves are logical and easily understood when someone explains them is understandable ways to novices.
I donât think any novices will benefit from the few messages already in this thread. They donât care about liquidity, synthetics, puts vs. calls. They want it kept simple and understandable, and practical.
They want the prospect of high yield without the need for constant monitoring. They have jobs and are not interested in exotic trades, scalping, forexs, and futures. Lets keep it simple. Let beginners start trading a simple strategy and grow into fancy stuff if they want to. Sticking to vertical spreads tends to minimize all that stuff anyway.
Learning how to do the trades and what they are is the price of admission to this club, but that is the EASY part. Learning the terminology is easy. Learning how to operate a trading platform like InteractiveBrokerâs is challenging, but this is still the EASY part.
The hard part is what follows, but the hard part is still common sense.
My goals are to discuss the issues that are challenging in using these spreads and determining what are the BEST solutions to these challenges.
Here are the big challenges:
1. Stock selection and market timing. Everybody who invests or trades has these problems. But the techniques used by participants in this strategy are vastly different from those used by day-traders, long term investors, and by those who use a thousand other spread strategies different than this one. Bull spreads donât work so well when the market is crashing down around our ears. So we donât enter these spreads anticipating that scenario. My contention is we don't have to become stock gurus, we have to become good at picking our sources of information.
2. Position management. What do we do when stocks rise and when they fall? What can we do to reduce risk and losses, and to maximize profits? What is a good exit strategy for this specific type of spread? When is the optimum time to implement these management techniques?
The post by FullyArticulate mentioned that things can go bad very quickly. He is absolutely right. When the shit hits the fan, it happens so fast it takes your breath away! These spreads are leveraged, and they move a lot from day to day. We expect that! We donât depend on luck or prayer, or good luck charms. The only way we withstand that vicious onslaught is to have a LOT of confidence in the prospects of the sectors and stocks we selected, or at least our ability to find the sources of information about them that we trust, and also to have a PLAN for position management to handle the situation. The novice should not be overly fearful about this. You stick your toe in the water and try it out first. You will grow into it.
3. How to properly diversify for safety. What are the consequences of having multiple positions in the same stock but with different strike dates or different strike levels? How does that affect margin requirements?
4. How to anticipate early executions and plan for them. How to anticipate expiration problems and how to avoid them.
5. How much cash do we keep on hand to handle maintenance issues? Rolling spreads? How can we raise cash from our positions when we need to?
There are many more issues that concern traders but they are more general in nature, like money management, margin issues, etc.
So Iâll listen to arguments about what is better bull put spreads or bull call spreads, but honestly I donât have any of the problems you talk about. I can enter and exit the positions just fine (mostly). I can easily find spreads that yield my target of 50% per year profit, assuming I have handled stock selection properly. I donât have a big problem with liquidity issues. I feel I am making optimal use of the funds I have available. If I can grow my portfolio by 40 to 50% anually, I really have no complaints.
I want to learn better techniques for stock selection and sector selection and timing my entries. All the rest is secondary.
If there are interested novices reading this, I still invite you to request a written document from me.
Don't mistake bull market for knowledge/edge. Just because your bullish strategy worked in a bull market doesn't make you a profitable trader over the long run!
This is probably the most competitve business in the world, so in order to have any chance of success you cannot afford to be sloppy or just too lazy to learn the trade! You don't care about giving up an nickel here or a dime there by trading ITM options rather than OTM, I can assure you, over time it adds up to quite a bit! You don't care about liquidity!? Sure you don't trading a few grand. Once you get to a reasonable size liquidity becomes a major issue, and believe me, understanding and knowing how to take advantage of the synthetics can make a huge difference!
But then again, the more clueless traders in the market the more profit potential for pros...
to MTE, you are making a lot of false assumptions about my trades.
I'm handling over $350k in spreads for me and family members. I'm handling over $200K in IRA accounts. I consider it an awesome responsibility, NONE of this money can be replaced if I screw this up. I have been handling this for several years.
I started using vertical bull spreads only 14 months ago as THE only strategy for maximum growth. There have been times when I worked very hard to make ridiculously little money (when I thought covered calls was a cool strategy for growth, but I NEVER LOST MONEY on these accounts during the months when my experience levels were lower than they are now.
What I have tried to do is become as good as I can at one single solitary thing, the DITM Bull CALL spread. I do worry about nickles I assure you. When I'm buying spreads, I'm searching for bad days in a rising market, or waiting for the shoe to drop in toppy markets. I watch the minute charts watching the stock price (with a firm memory of the yearly chart of the stock) and I wait for a good buy time on a day that the stock is gennerally trading in a range I like. Thats what I worry about, not puts and calls. I watch volatility like a hawk. I pay close attention to delta, and sometimes delta is a dealbreaker.
My nightmare is buy a position at it's high and watching it erode.
My nightware is not that I missed a good implied volatility entry point.
So maybe I am clueless.
I'm handling over $350k in spreads for me and family members. I'm handling over $200K in IRA accounts. I consider it an awesome responsibility, NONE of this money can be replaced if I screw this up. I have been handling this for several years.
I started using vertical bull spreads only 14 months ago as THE only strategy for maximum growth. There have been times when I worked very hard to make ridiculously little money (when I thought covered calls was a cool strategy for growth, but I NEVER LOST MONEY on these accounts during the months when my experience levels were lower than they are now.
What I have tried to do is become as good as I can at one single solitary thing, the DITM Bull CALL spread. I do worry about nickles I assure you. When I'm buying spreads, I'm searching for bad days in a rising market, or waiting for the shoe to drop in toppy markets. I watch the minute charts watching the stock price (with a firm memory of the yearly chart of the stock) and I wait for a good buy time on a day that the stock is gennerally trading in a range I like. Thats what I worry about, not puts and calls. I watch volatility like a hawk. I pay close attention to delta, and sometimes delta is a dealbreaker.
My nightmare is buy a position at it's high and watching it erode.
My nightware is not that I missed a good implied volatility entry point.
So maybe I am clueless.
I think what MTE meant that it is not possible to conclude that the strategy works based on 1 year of experience. It's not clear which part of the account you invest in buying these spreads, but be aware that the possible max loss is the full payed price for the spread. And that will happen one day.
A gain ratio of 25% would mean a possible loss of the other 75%. If that is brought down to an acceptible 2% of your account-size the gains would reduce from 25 to 0.66% per round.
More in general, I find that the price-ratio of these spreads is a fairly accurate estimator of the perceived risk of a underlying instrument. So, if you find a spread that costs 75% of the total strike-width this means that the market thinks there is a chance of about 75% that the spread will have both strike ITM at exp. It also means there is an estimated 25% chance it will have both strikes OTM at exp. Of course this is very crude, but it is to show that your own feelings about the probabilities aren't shared by the market. One should wonder why.
Ursa..
URSA - Now you're talkin'!
I live in Las Vegas. I don't gamble in the casinos cause I know the odds are with the house. In thirty years of casual nickles and a few quarters, my biggest hit was a $100 jackpot about 20 years ago.
I agree kindof about your quick 0dds assessment. I also think that if we throw darts at the business section of the paper to find stocks, or let a monkey pick them amd then find a spread that yield 25% return - that the expectation would be that the majority of the spreads would complete to full profit say 75% which seems intuitively correct. But what about the remaining 25%? Do we really expect that the spreads are all or nothing? No. Some of the spreads would end up ATM with the long spread exercides and the short spread expiring worthless. So of the 25% of the spreads that would lose, all else being equal, maybe
we would have 10% failing totally so return is zero, say 7% breaking even or returning less than full profit, and 8% being losses but no total losses. This is just a rough analysis, I think only a math major could get it more accurate.
So, even with monkeys picking stocks, I like the odds.
But there are mitigating factors that improve the odds of success.
We pick the stocks, not monkeys. We have to do a better job than the monkeys. We have to use our brains to see the big picture and study sector and stock prospects, Then the odds get better.
The odds also get better when we learn defensive tactics. Position management. When thing go sour, we don't panic, we don't run to our analyst, we don't sit there like a deer frozen on the highway. We go to work. We manage, we study, we tweak the spreads. Then the odds get better.
Cheer up folks - It aint brain surgery!
I live in Las Vegas. I don't gamble in the casinos cause I know the odds are with the house. In thirty years of casual nickles and a few quarters, my biggest hit was a $100 jackpot about 20 years ago.
I agree kindof about your quick 0dds assessment. I also think that if we throw darts at the business section of the paper to find stocks, or let a monkey pick them amd then find a spread that yield 25% return - that the expectation would be that the majority of the spreads would complete to full profit say 75% which seems intuitively correct. But what about the remaining 25%? Do we really expect that the spreads are all or nothing? No. Some of the spreads would end up ATM with the long spread exercides and the short spread expiring worthless. So of the 25% of the spreads that would lose, all else being equal, maybe
we would have 10% failing totally so return is zero, say 7% breaking even or returning less than full profit, and 8% being losses but no total losses. This is just a rough analysis, I think only a math major could get it more accurate.
So, even with monkeys picking stocks, I like the odds.
But there are mitigating factors that improve the odds of success.
We pick the stocks, not monkeys. We have to do a better job than the monkeys. We have to use our brains to see the big picture and study sector and stock prospects, Then the odds get better.
The odds also get better when we learn defensive tactics. Position management. When thing go sour, we don't panic, we don't run to our analyst, we don't sit there like a deer frozen on the highway. We go to work. We manage, we study, we tweak the spreads. Then the odds get better.
Cheer up folks - It aint brain surgery!
One problem I have with trading these spreads is knowing how to allocate capital. Do you have rule of thumb you are using for how much you risk per spread? How many do you have on at a time?