Need your help on put spreads

xandman · Mar 21, 2015

Thanks for the assist DTB2. I thought dislexia was something people were born with, but I seem to be getting it lately.

Seems like a moderate risk reward, ARNYC. Personally, I would have held to expiration since it was limited risk and I don't see CMG going all the way back that way by April17. Don't beat yourself up over it. Many traders will have different opinions.

ARNYC · Mar 25, 2015

xandman:

I think I might get back into a similar CMG trade in a few days (probably will check what this Friday holds and then)

AT99 · Mar 26, 2015

What I do is to look at how much a stock has moved over a similar time frame and try to pick strikes with a 90%-95% success rate. I limit it to historical periods when volatility is similar to today as measured by VIX. I do this mainly for SPX and AAPL trades, but just loaded some CMG data for you.

Here is how CMG looked on March 19th and what I would consider for April 17th spreads. The number of trading days holding would be 21 so I look at all past monthly op ex moves from 21 days prior. I use current VIX * 1.3 for limiting volatility to similar periods.

This spreadsheet then takes all the historical 21 day % moves and intra-period high and low % moves and converts it to today's CMG price.

A Bull Put Spread with a short strike of $575 or lower has a 92% success rate of not being pierced over the 21 day holding based on the past 50 month moves when VIX was below 19. If held until expiration, only 3 times of the 50 months did it close below $575.

I did not go back to look at what a CMG put spread with that short strike pays. I can typically get around 3-5% monthly when doing this with SPX spreads.

Here is what the CMG analysis for a 21-day trade looks like (these are trading days not calendar days).

http://screencast.com/t/ddLoDhzC

You can use some broker platforms to get the probability OTM percentages to do something similar. But that looks at probability at op ex only... I want to know how much the stock may move up / down intra-period as that is what would shake me out of a position.

AT99 · Mar 26, 2015

Looking at an April 17th BuPS today, here is how the numbers look using prior CMG close of $665.97, current VIX of 15.83, a VIX adjustment of 1.3, and 16 trading days until expiration.

90% of the past 16 day moves (when VIX was below 21), CMG has not pierced $605 over the holding period. The 600-605 BuPS is paying $0.15 premium so return is: .15 / 4.85 risked = 3% return.

An important thing to consider though is at what price you might be shaken out of the position. you would not necessarily hold until the short strike was hit. If you might exit / manage the position if CMG drops to $625, you can look down the Intra Period Low column and see where $625 is. It has fallen below $625 11 of the 59 months so there is a success rate of about 81%.

I have a "Distance for Management" field in the Strike Suggestions area that calculates this automatically. I put in $20 for Distance for Management and it shows below the success rates for the suggested strike and the "managed at" strike.

Here is how the trade looks if opening today:

http://screencast.com/t/a6DZuMB3Ih2

ARNYC · Mar 26, 2015

AT99, this seems quite interesting. But I have a question though. (Pls forgive me if it sounds amateurish)

Given that we are trying to "guess" where the stock (and thus the option) would be (in both direction and timing) as the stock does not move according to any formula, do we not get these parameters by simply looking at a weekly chart and picking the low points or past support levels we are comfortable with? Do you think all this work really gives us any more comfort than simply eye balling the chart and making the final selection of the spread we want to buy or sell?

Arnyc

AT99 · Mar 26, 2015

arnyc, that is a good question. There is definitely no one right way to estimate where a stock may be going. In fact, with the strategy I was showing you I try to estimate where I think the stock won't be (not where it is going) and then try to stay outside that range.

I use charts and technical indicators for directional trades, but I have made my most consistent returns over the years with credit spreads and staying outside the historical moves.

The difficulty with just looking at a weekly chart is you are not converting past % moves in CMG to today's dollars. And it is not easy to "scrub" the chart for times of similar volatility. This is why I decided to find a way to do that so I knew what the real historical move was in a stock in today's $$ and during similar volatility. I sell SPX credit spreads every week based on this info and collect 1-2% weekly. It is not a big return, but 1-2% weekly adds up to nice annual returns for the capital allocated to that strategy.

OTM-Options · Mar 27, 2015

AT99 said:
I sell SPX credit spreads every week based on this info and collect 1-2% weekly. It is not a big return, but 1-2% weekly adds up to nice annual returns for the capital allocated to that strategy.

Weekly credit spreads will not bring in 1% weekly over a 1 year period. Credit spreads are 8 small steps forward, 1 big step back. $10,000 at 1% weekly comes to $16,610.78 after one year - the inevitable losing trades will take a big chunk out of that.

$10,000.00
$10,100.00
$10,201.00
$10,303.01
$10,406.04
$10,510.10
$10,615.20
$10,721.35
$10,828.57
$10,936.85
$11,046.22
$11,156.68
$11,268.25
$11,380.93
$11,494.74
$11,609.69
$11,725.79
$11,843.04
$11,961.47
$12,081.09
$12,201.90
$12,323.92
$12,447.16
$12,571.63
$12,697.35
$12,824.32
$12,952.56
$13,082.09
$13,212.91
$13,345.04
$13,478.49
$13,613.27
$13,749.41
$13,886.90
$14,025.77
$14,166.03
$14,307.69
$14,450.76
$14,595.27
$14,741.23
$14,888.64
$15,037.52
$15,187.90
$15,339.78
$15,493.18
$15,648.11
$15,804.59
$15,962.63
$16,122.26
$16,283.48
$16,446.32
$16,610.78

AT99 · Mar 27, 2015

I have done this consistently with good results. It is not blindly entering a trade every week. You need to avoid more volatile weeks such as those with FOMC announcements or exit early for smaller gains that week. You also need to look at charts and know if we are near key support / resistance levels. Avoid trades when near these as there is a higher chance of a big move.

The key is to have good rules for entering trades and most importantly strict rules for exiting. And I will skip a week if the risk / reward is not what I like. Those I have seen lose money hold onto a loss longer than they should and turn a small loss that could be recovered in a couple of weeks into a much larger loss.

Focus on trades with a high probability of success (95%+). And this is based on where SPX has moved intra-week so trades are more conservative. Set a loss level where you are only giving up a couple weeks of gains.

Weekly trades have less time for management so I put more capital into monthly trades targeting 3-5% monthly. Still very nice annual returns and more time to manage if needed. Some months I can get 2 trades done if the first one hit near max gain early.

OTM-Options · Mar 27, 2015

AT99 said:
I have done this consistently with good results. It is not blindly entering a trade every week. You need to avoid more volatile weeks such as those with FOMC announcements or exit early for smaller gains that week. You also need to look at charts and know if we are near key support / resistance levels. Avoid trades when near these as there is a higher chance of a big move.

The key is to have good rules for entering trades and most importantly strict rules for exiting. And I will skip a week if the risk / reward is not what I like. Those I have seen lose money hold onto a loss longer than they should and turn a small loss that could be recovered in a couple of weeks into a much larger loss.

Focus on trades with a high probability of success (95%+). And this is based on where SPX has moved intra-week so trades are more conservative. Set a loss level where you are only giving up a couple weeks of gains.

Weekly trades have less time for management so I put more capital into monthly trades targeting 3-5% monthly. Still very nice annual returns and more time to manage if needed. Some months I can get 2 trades done if the first one hit near max gain early.

AT99 · Mar 27, 2015

Glad to see this forum has the ignore user button for those who have nothing productive to add.