Need a trade critique

D

dcwriter2

Hey, I know I risk a ton of snark here, but I'm curious about this OTM bear credit spread:

Underlying P = $35

Risking = $450

Expectation of profit based on delta: 95%

Questions:

1. What is fundamentally wrong? Rules of thumb I should know?

2. What would be the optimal trade size on a $185,000 account?

Thanks in advance.
 
[snark]"Doctor, I felt something in the upper half of my body at some point in the past. Is it cancer?"[/snark]

Seriously, though... :) If you want a critique, you've got to give as much accurate info about the trade as possible. Don't worry - none of us billionaires here are going to arb it out of existence the moment you tell us what it is. But it would be really nice to look at the actual options chain for that date, maybe even glance at a chart, and see all the pertinent info.

Example of a reasonable trade description:

SPY @ 452.20 22 Oct 21 451C/-454C 2.00db

Anyone who can comment intelligibly can figure the risk, deltas, etc. from there.

And yes, there's a bunch of rules of thumb for spreads. Far too much info for a forum post, but there are a few reasonably good videos on YouTube. Optimal trade size is up to you and your risk appetite, but a rough starting point might be a max risk of 1-2% per trade.
 
Expectation of profit based on delta is not the same as probability of success of the trade. If the stock moves higher that probability can move to 80% or 60% depending on the size of the move.

If stocks moves a little and vols start getting juiced you can start losing money right away and have to hold on until decay kicks in more.

Also without more details your trade looks like the kind that cna make $1.00 each 9 times out of 10 and on the 10th time loses $20.
 
dcwriter2 said:
Not make a profit 19 out of 20 times (35X19=$665) and lose one out of 20 (-$450)?
More...


Unfortunately that is not how it works with selling $0.05 bear call spreads...you are making pennies so it seems like high probability but markets can spike up and you will erase plenty of gains. I am not saying it is a viable strategy when the vols/strike prices/premiums/technical analysis calls for it but I always caution people to looking at it as a wash rinse repeat strat you can do always without understanding the underlying risk v reward
 
dcwriter2 said:
Not make a profit 19 out of 20 times (35X19=$665) and lose one out of 20 (-$450)?
More...

Trade expectancy is calculated as

Reward x Win probability - Loss x Loss probability

Unless you have some specific edge, the default expectancy for a trade on entry is zero. If there was any other possibility, everyone in the market would pile into a trade that offered it and we'd all retire to our private islands.

What the market is telling you, via pricing, is that the expectations you described above are wrong, and you're overestimating your win prob and underestimating your loss prob. If you believe you're right and the market is wrong, then you should take that trade again and again and prove it.

One more thing: FOTM options lack the granularity of the ones that are closer to the money, so you will generally be underpaid for the risk you're taking.
 
95% edge?
with $185,000 you get ...

.95*(ln(185000+ X)) + .05*(ln(185000-X))

maximize it by taking derivative and solve for X ...
.95/(185000+ X) - .05/(185000-X) = 0
 
dcwriter2 said:
Hey, I know I risk a ton of snark here, but I'm curious about this OTM bear credit spread:

Underlying P = $35

Risking = $450

Expectation of profit based on delta: 95%

Questions:

1. What is fundamentally wrong? Rules of thumb I should know?

2. What would be the optimal trade size on a $185,000 account?

Thanks in advance.
More...

Can you provide more context regarding what you provided here? What do you mean by "Risking"? Is that the cost of the entire combo? Potential loss? Or a combination of both? And this includes commission or excludes commission?

And "Expectation of profit based on delta"? What is that? Is that the maximum gain? Or % of probability of maximum gain? What does it mean by "based on delta"? There is no such thing as "based on delta" because delta is dynamic; it can change according to what's going to happen to PA in the future.

If you can provide more clarification, then more analysis can be done.
 
dcwriter2 said:
Hey, I know I risk a ton of snark here, but I'm curious about this OTM bear credit spread:

Underlying P = $35

Risking = $450

Expectation of profit based on delta: 95%

Questions:

1. What is fundamentally wrong? Rules of thumb I should know?

2. What would be the optimal trade size on a $185,000 account?

Thanks in advance.
More...

1. Only wrong assumption here is that delta (assuming it was derived w/ implied) = future probability of price distribution. More likely than not, it's a 0EV trade over time before transaction costs.

2. How do you personally define "optimal"?
 
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