Naked or spread

[arm0211]

Thank you for your inputs. These are just the two concepts I have started looking at during my first month of trading. I realize just because this month was successful, doesn't mean all months will be like this. This is the reason why I was looking into more risk friendly alternatives. I get why a 5% monthly return is attractive, but i'd rather not risk a blowout and settle for moderate returns. My favorite professor in college always told us, "You can never separate risk from reward.".

The problem I am encountering with verticals is not being able to roll for a credit once the position goes against me. Rolling Verticals seems to be more difficult to manage.

As well as needing to win more than 80% of the trades to be profitable.

lets say I sold 5 otm individual spreads all $1 wide strike and obtained on avg .13 credit.

max loss $500-65= $435
Max gain = $65

0/5 = ($435)
1/5 = ($335)
2/5 = ($235)
3/5 = ($135)
4/5 = ($35)
5/5 = $65

any risk defined strategies for traders looking for preservation of capital with growth potential?

 

[viruscore1]

When selecting stocks to sell puts on, complete proper analysis. The odds of the stock dropping to unmanageable levels is minimized when value exist. Select the strike price wisely, you may own the stock at that price. Most, if not all good stocks retrace to the mean, which i use as a guideline.

 

[spindr0]

I trade shorts often but do not use spreads, the management of spreads are more complex and beyond my capability. I don't know how to model underlying, IV and the rest of the greeks effectively in a spread. Maybe someone is willing to give me a hand and give me some suggestions.

Spreads aren't difficult to manage. If you're comfortable selling a short put, the long put is just crash protection. AFAIC, modeling IV and Greeks isn't that important for verticals since though not equal, IV change affects both legs so they offset to some extent. If you're trading some diagonal variation to capitalize on earnings announcement IV contraction then it's a different story.

The trick with a short option (naked) is getting the direction right and that does not change just because you added a long leg for crash protection (vertical).

 

[spindr0]

The only time when I would do naked puts is to buy a stock at discount. In any other case, not only it exposes you to (theoretically) unlimited risk, but it is also very inefficient use of margin compared to spreads.

That's it in a nutshell.

 

[spindr0]

The problem I am encountering with verticals is not being able to roll for a credit once the position goes against me. Rolling Verticals seems to be more difficult to manage.

Verticals are more difficult in that they involve more legs.

As well as needing to win more than 80% of the trades to be profitable. lets say I sold 5 otm individual spreads all $1 wide strike and obtained on avg .13 credit.

max loss $500-65= $435
Max gain = $65

0/5 = ($435)
1/5 = ($335)
2/5 = ($235)
3/5 = ($135)
4/5 = ($35)
5/5 = $65

I have no idea if you are trying to compare different verticals and why you are averaging them, or what. You might want to be more specific in order to make it easier to understand what you are asking. Include the specifics of the legs involved. For example, sell Dec 50p for .85 and buy Dec 48p for 20 cents for a credit of 65 cents.

 

[spindr0]

any risk defined strategies for traders looking for preservation of capital with growth potential?

A vertical is a risk defined strategy.

A short put has an imbalanced R/R ratio since a loss could be anything (down 2, 5, 10, 25 pts ?). A vertical shifts the R/R closer to even and has a lower margin requirement.

Prior to expiration, the vertical will lose less than the short put because the long put gains in value during a drop.

Comparing the strategies, at expiration, the break for the vertical versus the short put is the long strike less the premium paid for it. Above that BE point, the short put outperforms. Below it, the vertical loses nothing more while the short put continues to lose.

With the spread you get a much higher ROI and no chance of getting whacked if the stock collapses. Is giving up a chunk of the short premium worth the higher ROI and disaster protection? That's a personal choice - I say yes. Higher vols provide a larger spread credit? Lower vols presents a more challenging choice.

If you have the ability, set up a spreadsheet with the trade I mentioned in my previous reply -> Sell Dec 50p for .85 and buy Dec 48p for 20 cents for a credit of 65 cents. Compare that vertical with just selling the Dec 50p for 85 cents. Look at the performance of each from $50 down to say $40. FWIW, as per the previous reply, the loss on both positions is equal at $47.80 (-$1.35)

 

[arm0211]

Verticals are more difficult in that they involve more legs.



I have no idea if you are trying to compare different verticals and why you are averaging them, or what. You might want to be more specific in order to make it easier to understand what you are asking. Include the specifics of the legs involved. For example, sell Dec 50p for .85 and buy Dec 48p for 20 cents for a credit of 65 cents.

I’m just making the point if i make 5 trades and 1 goes against me, then I’m in an over all loss.

 

[spindr0]

I’m just making the point if i make 5 trades and 1 goes against me, then I’m in an over all loss.

That's true but if you're selling $1 wide credit spreads for a 13 cent credit, odds are that the short strike is a fair amount OTM and you have some buffer until it comes into play. Only a huge gap that drives the options to parity will cause that maximum loss so I don't think it's a dire as you suggest.

 

[TrustyJules]

Thank you for your inputs. These are just the two concepts I have started looking at during my first month of trading. I realize just because this month was successful, doesn't mean all months will be like this. This is the reason why I was looking into more risk friendly alternatives. I get why a 5% monthly return is attractive, but i'd rather not risk a blowout and settle for moderate returns. My favorite professor in college always told us, "You can never separate risk from reward.".

The problem I am encountering with verticals is not being able to roll for a credit once the position goes against me. Rolling Verticals seems to be more difficult to manage.

As well as needing to win more than 80% of the trades to be profitable.

lets say I sold 5 otm individual spreads all $1 wide strike and obtained on avg .13 credit.

max loss $500-65= $435
Max gain = $65

0/5 = ($435)
1/5 = ($335)
2/5 = ($235)
3/5 = ($135)
4/5 = ($35)
5/5 = $65

any risk defined strategies for traders looking for preservation of capital with growth potential?

The key to this strategy is how you avoid the big drawdowns or at the very least mitigate their effect. The reason you cannot roll is that your initial credit is paltry certainly when taking into account inevitable trading costs which spiral when rolling. Any spread I sell, I try to get at least 1$ credit give or take a bit and because this means I have to be closer to the money I am also able to roll if need be.

Your strategy looks like a statistical loser - 80% batting rate means that 1 in 5 times you get whacked, if you take the full loss this more than wipes out any earnings you have made.

 

[jimmyjazz]

I've certainly seen plenty of discussion by seemingly "good" traders who prefer to trader closer to the money, even with spreads, and they accept the fact that they'll have to adjust more often. I don't know if it's human nature at work for everyone but my own nature tends to make me averse to adjusting, and I get into "hope" mode when things start to go south. At that point things usually go further south.