[newbie question #2] What is the minimum risk for a bull put spread?

N

nwoptions

Hi guys,

I have a question about the minimum risk involved in trading a bull put spread.

Let's say the stock is at $389.

I sell the Sept. 18-expiring 370 put. And buy the 360 put. This gives me around $295 in premium per contract.

Max profit: $295 per contract
Max risk: $705 per contract

My stop loss: $375. If the stock dips below this price, I will unwind the position to avoid larger losses. The short put doesn't get exercised.

My question: if the stock reaches $375 and I decide to buy back the short put and sell the long put to close the position, what are my total costs? In other words, what's the minimum risk involved with this trade?

Do I just pay the broker's commission fee to close the trade? Or are there other costs involved that I'm missing?

Thanks
 
nwoptions said:
Hi guys,

I have a question about the minimum risk involved in trading a bull put spread.

Let's say the stock is at $389.

I sell the Sept. 18-expiring 370 put. And buy the 360 put. This gives me around $295 in premium per contract.

Max profit: $295 per contract
Max risk: $705 per contract

My stop loss: $375. If the stock dips below this price, I will unwind the position to avoid larger losses. The short put doesn't get exercised.

My question: if the stock reaches $375 and I decide to buy back the short put and sell the long put to close the position, what are my total costs? In other words, what's the minimum risk involved with this trade?

Do I just pay the broker's commission fee to close the trade? Or are there other costs involved that I'm missing?

Thanks
More...

As I explained earlier (try reading your own threads!), you will pay the spreads. Which can be substantial if you're trying to unload a position at a stop loss.

The options market can often be very inefficient, so never assume that you're going to beat the spread.
 
Thanks for your reply lindq. So you're saying it's commission + spread = bare minimum loss I'll experience if the stock hits my stop loss?

In your experience, what sort of loss have you experienced when this happens? Am I looking at something like a loss of $50 per contract?
 
nwoptions said:
Thanks for your reply lindq. So you're saying it's commission + spread = bare minimum loss I'll experience if the stock hits my stop loss?

In your experience, what sort of loss have you experienced when this happens? Am I looking at something like a loss of $50 per contract?
More...

No, I did not say any such thing. I have no idea what your maximum loss might be. I am only identifying what your MINIMUM loss is likely to be, which is what you are paying in spreads.

Look at your option contracts. Calculate realistically the cost of your spreads as a percentage of your capital invested. The fact that most traders fail to do this is a big reason why most traders lose money.

And two final points I will make. (1) Are you experienced enough to have confidence that you can predict the movement of the underlying security? If not, then you should not be in the options market. (2) If you feel you must trade options for some reason, then the best way to learn is to trade them. You don't learn to swim without getting wet. Start with a single contract and watch and learn.

Good luck.
 
Legging out has unknown risks as the price can move sharply while you are trying to buy one and sell another.
For example, the price moves to 375 and you decide to get out. You buy to cover your short put at 375 and the price starts to rise before you can sell the long put. You wait to see if the price will come back, and it goes higher, then it jumps a dollar, etc...
The greeks will help you see how the option value will change as the underlying price, volatility, and time changes. Find an options calculator and slide the figures around.
 
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LanceJ said:
Legging out has unknown risks as the price can move sharply while you are trying to buy one and sell another.
For example, the price moves to 375 and you decide to get out. You buy to cover your short put at 375 and the price starts to rise before you can sell the long put. You wait to see if the price will come back, and it goes higher, then it jumps a dollar, etc...
The greeks will help you see how the option value will change as the underlying price, volatility, and time changes. Find an options calculator and slide the figures around.
More...


Thanks for your reply LanceJ. Can you tell me what the typical loss looks like when you unwind your spread? Is it something like $20 per contract? $50? $100? I'm just trying to get an idea of what the bare minimum loss (not the max loss) would be when I unwind the position when the stock hits my stop loss.

Thanks again.
 
It depends on a few things.

First off, what did you pay for the 360 puts and what did you receive from selling the 370 puts?

When trading spreads, usually your max loss IS the stop loss, if you size the trade accordingly.

If you are trading with some size, then don't trade at all if you're asking this question.

Because if the stock is at $375 in Sep, your spread will be a winner. So it depends on how soon the stock declines, then calculate the strike in relation to spot and you'll get your values.
 
I use the max loss as my stop loss. One of the benefits of the static hedge is not getting shaken out, the long put is your protection.
I have a feeling that your position is too large because you are not worried about losing $705, you are worried about losing multiples of $705.
Your size has been determined by how much premium you want to earn.
You are still assuming you would be able to get out perfectly if the price declines. What if the price gaps down to $350?
My max loss per static hedge is never more than 5% of my total portfolio value.
Again, check out the option greeks and position greeks to know how the spread value will change as price, volatilty & time changes.
 
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