SPX Credit Spread Trader
- Thread starter El OchoCinco
- Start date
Attached is a risk/reward profile of a PREGO FLY.
The assumptions are that I entered 100 1190/1200 Put Spreads at $0.50 and then added 25 1240/1200 put debit spreads to roll into Prego Fly for a net debit of $2,875. So Instead of risking $95,000, I turned the position into a limited risk of $2,875 with a profit potential of $97,125. I would have rolled into this if I saw the market moving lower and expected continued movement lower towards my short strike beofre expiration. If I was wrong then I take a limited loss and I hedge my exposure. If I was right I could make a significant profit from a hedge.
And under risk-based haircut, I could sell another 100 spreads deepr OTM and reduce the net debit, pay for it entirely, or still produce a net credit and a profit if the makret stays higher.
The assumptions are that I entered 100 1190/1200 Put Spreads at $0.50 and then added 25 1240/1200 put debit spreads to roll into Prego Fly for a net debit of $2,875. So Instead of risking $95,000, I turned the position into a limited risk of $2,875 with a profit potential of $97,125. I would have rolled into this if I saw the market moving lower and expected continued movement lower towards my short strike beofre expiration. If I was wrong then I take a limited loss and I hedge my exposure. If I was right I could make a significant profit from a hedge.
And under risk-based haircut, I could sell another 100 spreads deepr OTM and reduce the net debit, pay for it entirely, or still produce a net credit and a profit if the makret stays higher.
This is a very nice graph of a preg fly. Excellent risk reward- risk $2500 to make $97K. The issue is that you have to leg into these which assumed you will be taking delta risk on the leg. Guess right you have this graph, guess wrong and your debits balloon and the consequent payoff profile diminishes. There would be no way this profile would present itself w/o taking on leg/vol risk. Am I way off?
I just ran this on the OX trade calculator just using market prices. It shows a margin requirement of $100,000. From what you are saying about prop shop hair cut, the real risk if trading with the prop shop is your debit. That obviously makes a HUGE difference for us retail traders. I guess if I got in this situation I would pull up the graph and get in touch with the OX compliance department and plead my case.
ryan
I think you missed the point of the lead up to this graph. This is not a position you would open. This position is what you would do if you have an OTM credit spread and the market starts moving against you and you fear that it will keep moving stronger against you so you leg into it.
I am not looking to take any leg risk really because I am not trying to get into this position. I am selling a credit spread and looking to profit 100% from it. If the market moves as I said, then I will leg into this as a hedge first, and second a potential for increased profits, but the primary reason is to hedge my risk.
So you cannot look at this as a position to leg into on purpose or with that intention. I would only leg into PREGO FLY when I absolutely have to.
I am not looking to take any leg risk really because I am not trying to get into this position. I am selling a credit spread and looking to profit 100% from it. If the market moves as I said, then I will leg into this as a hedge first, and second a potential for increased profits, but the primary reason is to hedge my risk.
So you cannot look at this as a position to leg into on purpose or with that intention. I would only leg into PREGO FLY when I absolutely have to.
That is exactly the answer I got from OX when for a test case I asked them this scenario. The immediate answer was that each spread would have its separate margin requirements. I was told I could call compliance and make my case but no idea if you would get a willing ear.
I appreciate your reply. I want to make sure I understand your point. So permit me to illustrate. If I sold an OTM put vertical 4 days ago and now that the mkt is 25 ES points lower, you are saying u can button up your risk by turning the sold put vertical into a fly? I agree, have done that numeours times BUT it would be virtually impossible to get that kind of risk reward since the put vertical you need to buy to button up the downside risk now costs twice as much. Ditto for the calls. If I had sold a call vertical and the mkt roars up, I can leg into a preg fly by buying a call vertical but it would be $2 higher than before the move. So I don't quite understnad how you can sell something , be wrong , put on a fly with a RR of $2500 to $97000. If you found said strategy don't broadcast it coz u just found the grail.... LOL. Thanks again.
I think you are focusing on the trees instead of the forrest. I created an example to show what the spread would look like and used some numbers to illustrate. I was not intending to use these numbers as the fixed rule for every single trade you can enter. Assume then the net debit is $12,000. You turned a $95,000 risk position into a $12,000 limited risk position with the potential for $88,000 in profits. Also it is not the price of the spread as much as the number of contracts you are selling. The wider the debit spread you are adding the less contracts you need to sell. So the net debit total for entering the spread is what is important.
Remember the point is to add this ONLY when the shit is hitting the fan and you might be at serious risk. This is one method of chopping off a significant part of your risk and still possibly getting a large profit (a risk hedge with a built in lottery ticket if you will). I am not looking to do this position, I will do it when I am forced to. I am sure if I rolled my position down or closed it, it would cost me more than $12,000 and I would have to sell a lot of spreads to offset that cost. This way I clamp down the risk immediately and I can still choose to sell more deeper OTM spreads to take that loss down even further. This will work great with risk-based haircuts not in retail.
Now at expiration assume my loss ends up being $8,000. Given the size of my positions and profits, I will gladly take this loss because I would only roll when I am in serious danger (SEPT crash after Katrina and Thanksgiving surge are two times I really had to adjust and was in danger of larger losses).
So the actual net debit does not matter to me really. As long as it is less than the cost of rolling or closing and I really feel the market will still keep moving against me, the risk/reward profile improves 100% compared to the endangered credit spread.
I did not mean to imply overly optimistic pricing with my example, it was more to illustrate the risk graph.
Also, time to exiration is a factor. If you are closer to expiration, theta helps you get in cheaper than 4 weeks to expiration so all thse factors come into play.
It is important to remember that this is a way of hedging. I did not state that as soon as the market moves lower you slap on a PREGO FLY. A 25 point move over a few days is not enough by itself to make me need to convert.
Remember the point is to add this ONLY when the shit is hitting the fan and you might be at serious risk. This is one method of chopping off a significant part of your risk and still possibly getting a large profit (a risk hedge with a built in lottery ticket if you will). I am not looking to do this position, I will do it when I am forced to. I am sure if I rolled my position down or closed it, it would cost me more than $12,000 and I would have to sell a lot of spreads to offset that cost. This way I clamp down the risk immediately and I can still choose to sell more deeper OTM spreads to take that loss down even further. This will work great with risk-based haircuts not in retail.
Now at expiration assume my loss ends up being $8,000. Given the size of my positions and profits, I will gladly take this loss because I would only roll when I am in serious danger (SEPT crash after Katrina and Thanksgiving surge are two times I really had to adjust and was in danger of larger losses).
So the actual net debit does not matter to me really. As long as it is less than the cost of rolling or closing and I really feel the market will still keep moving against me, the risk/reward profile improves 100% compared to the endangered credit spread.
I did not mean to imply overly optimistic pricing with my example, it was more to illustrate the risk graph.
Also, time to exiration is a factor. If you are closer to expiration, theta helps you get in cheaper than 4 weeks to expiration so all thse factors come into play.
It is important to remember that this is a way of hedging. I did not state that as soon as the market moves lower you slap on a PREGO FLY. A 25 point move over a few days is not enough by itself to make me need to convert.
Well the credit spread risk profile looks like a backwards Z with the loss line much farhter below the $0 line than the profit line is above it. This is the same risk profile for a bull call spread deep ITM. When converted it looks like the chart (ignoring the actual $$) I posted above.
I am not sure what you mean. Also I am probably the worst one to do it since I never used that function of ToS.
I am not sure what you mean. Also I am probably the worst one to do it since I never used that function of ToS.