Question: Managing Profitable Debit Spreads

T

tommo

Hi,

I like to trade ATM Debit spreads for directional plays, usually 0DTE. Often within the first couple of hours I can be well onside in the trade and I have a dilemma. There is still enough extrinsic premium in the short leg to mean I am not at max profit on the trade and the risk:reward just doesnt play out if I'm closing debit spreads before i've realised most of the potential profit.

But on the flip side, sitting on a profitable position that could just reverse doesn't seem optimal.

So I see I have a few options:

1/ Assuming i'm in a profitable call debit spread I can buy a put spread as a hedge, but that changes the trade and costs premium.

2/ Just leave the trade and let the odds play out.

3/ Sell my short call thats in the money and roll it up. This will bring in more credit lowering my cost basis and if the market turns I can roll this down. If the trade carries on going up I get a bigger winner from the additional extrinsic value I sold.

I've been around trading long enough to know there are no perfect answers but 3 does seem to make intuitive sense and I often do it, but is there a reason why statistically this is flawed/positive in the long run?

Thanks
 
I don't understand #3 (selling short calls). You must have meant selling long calls.

If you are that good at predicting direction in short time period, you are better off buying stock or buying calls outright. The short leg will only hurt you as you get closer to the strike in a short period of time.
 
newwurldmn said:
I don't understand #3 (selling short calls). You must have meant selling long calls.

If you are that good at predicting direction in short time period, you are better off buying stock or buying calls outright. The short leg will only hurt you as you get closer to the strike in a short period of time.
More...

Im referring to debit spread so long one call and short the next call, sorry I mistyped, i meant to say, buy back the short call thats now in the money and roll it up.

As for predicting the market, i have a backtested system that predicts with around 64% accuracy if the following day is likely to be an up day, but not by how much it will positive, could be a tick, could be 500, and so by having approximately a 1:1 risk reward on a position i've built a positive expectancy.
The problem with trading outrights is the market can go down an unknown amount before returning positive on the day and playing around with stop losses breaks the binary nature of the edge I have found (does it finish up or down on the day).

Buying calls outright means it has to go up a certain amount to make money so ATM debit spreads seem the best way to express my hypothesis on the next days likely move.

I have also experimented with selling ATM puts but because I like to hold these from close to close it means I have overnight exposure when i'm unhedged, so again this brought me back to debit spreads
 
tommo said:
Im referring to debit spread so long one call and short the next call, sorry I mistyped, i meant to say, buy back the short call thats now in the money and roll it up.

As for predicting the market, i have a backtested system that predicts with around 64% accuracy if the following day is likely to be an up day, but not by how much it will positive, could be a tick, could be 500, and so by having approximately a 1:1 risk reward on a position i've built a positive expectancy.
The problem with trading outrights is the market can go down an unknown amount before returning positive on the day and playing around with stop losses breaks the binary nature of the edge I have found (does it finish up or down on the day).

Buying calls outright means it has to go up a certain amount to make money so ATM debit spreads seem the best way to express my hypothesis on the next days likely move.

I have also experimented with selling ATM puts but because I like to hold these from close to close it means I have overnight exposure when i'm unhedged, so again this brought me back to debit spreads
More...

This is different from what you said in the OP.

You are still better off either buying the stock or just buying the outright call.

You can buy fewer outright calls than callspreads (same cash outlay) and do much better on the 500 point days and only a little worse on the 1 tick days.

Or model your position such that you expect to have a call spread that's worth substantially less than the max pnl.

Trading spreads before expiry is inherently a volatility trade as the position will be time value that is a market forecast on future volatility.
 
An example would help,and the logic for choosing the long and short strike.

Adjstment #1) Appears to be some form of a delta hedge..Is buying the put spread that more efficient than trading underlying as a hedge? Im assuming you are buying an OTM put spread,creating a syn short fly,most likely unbalanced...

Adjustment #3) The opposite hedge of number 1. Dont like where you are heading..

You are trading a system,removing the subjective element,and now bringing in "gut feel" adjustments...

One hedge reduces delta,the other increases it...

Do you know the distribution of returns for your system??

If nothing else,Avg gain/loss,max gain vs max loss...

Then you can reply to NWD and have some idea of choosing outright call vs spread vs stock











tommo said:
Hi,

I like to trade ATM Debit spreads for directional plays, usually 0DTE. Often within the first couple of hours I can be well onside in the trade and I have a dilemma. There is still enough extrinsic premium in the short leg to mean I am not at max profit on the trade and the risk:reward just doesnt play out if I'm closing debit spreads before i've realised most of the potential profit.

But on the flip side, sitting on a profitable position that could just reverse doesn't seem optimal.

So I see I have a few options:

1/ Assuming i'm in a profitable call debit spread I can buy a put spread as a hedge, but that changes the trade and costs premium.

2/ Just leave the trade and let the odds play out.

3/ Sell my short call thats in the money and roll it up. This will bring in more credit lowering my cost basis and if the market turns I can roll this down. If the trade carries on going up I get a bigger winner from the additional extrinsic value I sold.

I've been around trading long enough to know there are no perfect answers but 3 does seem to make intuitive sense and I often do it, but is there a reason why statistically this is flawed/positive in the long run?

Thanks
More...
 
ODTE...
price starts at 3985.
Lets say its a 3990/4000 call spread on spx, (this will only work if there are available strikes between your strikes)

Lets assume the price goes to 4005
Original trade is ITM now

Sell a call spread against the ITM debit spread. ie the 4005/4015 and take in the credit..

Have a free condor/butterfly (3990/4000/4005/4015)
Trade is still open, on for a credit, the chance is still there for the rest of the day.

As long as the spread you sell is more expensive than what you bought you are good.

Wash, rinse, repeat!

I only suggest this because you stated you reach a point where you don't want to give profits back, if the market is still moving up, keep the long debit, but if unsure.. sell against it..

N2M
 
Last edited:
That’s not a 0dte option. That’s just adding risk after your trade has earned.

N2M said:
ODTE...
price starts at 3985.
Lets say its a 3990/4000 call spread on spx, (this will only work if there are available strikes between your strikes)

Lets assume the price goes to 4005
Original trade is ITM now

Sell a call spread against the ITM debit spread. ie the 4005/4015 and take in the credit..

Have a free condor/butterfly (3990/4000/4005/4015)
Trade is still open, on for a credit, the chance is still there for the rest of the day.

As long as the spread you sell is more expensive than what you bought you are good.

Wash, rinse, repeat!

I only suggest this because you stated you reach a point where you don't want to give profits back, if the market is still moving up, keep the long debit, but if unsure.. sell against it..

N2M
More...
 
You must log in or register to reply here.
Back
Top