SPX Credit Spread Trader

IF I had a TON of money I would absolutely agree with Mav and put my money to work buying calls/puts. BUT ...I DON't and am so much more comfortable being a seller than a buyer of premium.
 
So you're saying:

..1) a debit spread and a credit spread are equivalent, the bank's loaning you the money up front in the case of a credit spread

..2) this game's expectancy is zero (negative actually, given spreads and commissions)

..3) it's a zero sum game

So my question is:

..1) why play this game at all?

..2) how do you build a position that is net long contracts but short premium? By buying lots of far OTM lotteries?

I'm sceptical about your analysis. It's simply another take on the random walk theory which Buffet and your street corner hedgie has proved incorrect many times over by now...


Quote from Maverick74:

Murray, you are not mistaken. Although I fear on this thread, and it's no fault to Phil, that people become fanatical about their ideas. Whether it be over politics, religion, or even trading. We latch on to something and then refuse to ever look at the other side of the coin because we want to believe it so bad.

I could write 100 pages about the idea of selling premium over buying premium and vice versa. But I would not know where to start or where to end.

Let's try this for a minute. Let's remove the whole idea of the greeks. Let's simply look at options as a bet on fair value. When I interviewed in Chicago for the first time to work for a market making firm on the floor, all the companies asked this question.

They said you are going to play a game with one six sided die. You roll the die, whatever number comes up, you get that much money. So if you roll a 3, you get $3. If you roll a 6, you get $6. You are going to play the game over and over again. There are two players in this game. The roller and the house. The house is selling the bet, or selling premium if you will. The roller is buying the juice. The question is, as the roller, how much would you pay for the right to roll the die. Then, when you are the banker, how much would you sell the bet for?

For most of you you can figure out this is a very simple probability game that you probably played in your stats class in college. The fair value of the bet is 3.5. You get this number by summing the outcomes and dividing by the total.

(6+5+4+3+2+1)/6=3.5

That means the fair value of this bet over a long series of throws is 3.5. So if you are the roller, you want to pay less then 3.5 for the bet, say 3.4. If you are the banker, you would want to sell this bet for more then 3.5, say 3.6. What you just did is you made a market. You are 3.40 bid at 3.60 offer.

Folks, this in a nutshell is what options are all about. It does not matter if you are the roller or the banker. The person buying the premium or selling it. If you buy the option below fair value, you will make money. If you sell it for more then fair value, you will make money. Market makers have been doing this since 1973 and nothing has changed since then except the technology.

The whole idiocy of buying vs selling premium is as bad as the whole red state/blue state garbage. If you can grasp this very simple concept, trading options will become much more simpler for you.

Yes, over the long run, the buyer of premium will generally outperform the premium seller for one reason and one reason only. Not because he/she is a better trader. But because of something called luck. That's right, luck. Luck, is very much like volatility in that it doesn't have a positive or negative bias. It simply is what it is. You will have both good and bad luck in your life. The difference here is that when you have good luck as the long premium trader, you might retire off of it. Bad luck to the option seller will bankrupt him/her. Good luck will do nothing for the option seller as there is very little upside in what they are doing.

This brings me to one of my favorite quotes from the movie "Rounders":

"Amarillo Slim, the greatest proposition gambler of all time, held to his father's maxim: You can shear a sheep many times, but skin him only once. "

Well, that is what an option seller is trying to do. Their only hope is that they can sheer a sheep 1000 times before they get burned. The inverse is then true for the option buyer, bad luck is really not going to hurt him/her.

Now something to keep in mind here. I'm making lots of broad generalizations here. In my opinion, one should do both. I prefer to buy cheap tickets and sell fat juice. I prefer to be net long contracts but net short premium. The best of both worlds.

My argument here is not with the strategy or viability of it, but rather the assumption that it works better because you have a net credit. The net credit is meaningless as is the net debit. Just remember the dice game. Fair value, makes no difference if you are the banker or the roller. Everything else is just conversation.
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Mav,

This type of insight is priceless! Whether you're a buyer or a seller, or even know much about options. This premise exposes a whole other layer. Anyone who doesn't appreciate, or fails to see the the point being made here, should STOP IMMEDIATELY what they're doing until they do, imho.

Thanks again for the insight. I don't even trade options in any form, anymore. However, I do appreciate the contributions here, especially those of a select few, Mav being one.


Good Day and Good Trading!

Kelly
 
Quote from Maverick74:



I could write 100 pages about the idea of selling premium over buying premium and vice versa. But I would not know where to start or where to end.
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That painfully reminds me of my first year of options trading where i thought selling premium and collecting on theta was the holly grail.

It wasnt until later that i learned to make money with options not only do you have to buy cheap(below fair value), and sell expensive but ALSO you have to be right on the direction or lack of direction in the underlying.

Simply put, the credit we all receive when we sell a spread isnt really our credit until the options expire. Thinking that it belongs to us is a misconception that many traders have albeit their preference over using debit spreads.


Quote from Maverick74:



Yes, over the long run, the buyer of premium will generally outperform the premium seller for one reason and one reason only. ...... The difference here is that when you have good luck as the long premium trader, you might retire off of it. Bad luck to the option seller will bankrupt him/her. Good luck will do nothing for the option seller as there is very little upside in what they are doing.
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I dont know if i would agree that being long premium is better than being short premium over the long haul. If the risk management approach is EXACTLY the same, if the strategies used imply EXACTLY the same outlook on the underlying and that's the only time we can even compare the two approaches, that is when those two shouldnt be much different from one another. While the short seller may go bankrupt in those few rare cases. The premium buyer may not survive enough to see the lottery ticket payoff because of drawdowns.
 
Mav:

You make some good points and, speaking for myself, your comments are welcome on this thread. I happen to be a believer that one should always examine why they are doing something so that the full implications of what they are doing stay fresh. To examine something, IMO, you have to look at the other side, which is what you are asking us to do.

Even though many of us may not take your advice, it does not go unnoticed. I do think that at the very least your posts make us stop and think and that in and of itself is valuable.

I've actually been considering placing debit spreads using a portion of the SPX credit spread premiums I collect. But I'm not sure that the SPX would be the right instrument for purchasing debit spreads. Coach pointed to the SPY and the XSP because the b/a is somewhat tighter. As he noted earlier, SPX b/a tends to be wider.

Thanks for the posts.

Quote from Maverick74:

Murray, you are not mistaken. Although I fear on this thread, and it's no fault to Phil, that people become fanatical about their ideas. Whether it be over politics, religion, or even trading. We latch on to something and then refuse to ever look at the other side of the coin because we want to believe it so bad.
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Donna:

While I was drafting my previous post on Mav's post, I was thinking of a strategy that you often use.

Namely, don't you often buy the long leg and then wait to put on the short leg. When you do that, don't you have a directional bias, at least for that moment. Then at some point in time, which you seem to be quite successful at determining, you either let it ride or convert to a credit spread. So, in effect, aren't you playing both sides of the street and simply adjusting to roll with the punches?

My version of "kind of doing the same thing" is to not put all my positions on at once. It allows me to roll more "with the punches" but I'm not playing both sides.

Can I ask what your success rate has been on those trades and what's your overall impression of how successful they are?

Quote from DonnaV:

Someone smarter can answer this....Is the probability higher that we can guess where something WILL NOT be than where something WILL be...IOW selling far OTM credit spreads we are saying the SPX will NOT be lower/higher than thus and such VS in buying a spread we are are saying the SPX WILL be thus and such.

When we BUY a spread are we not trying to be MORE precise than when we are SELLING the same spread?
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Quote from DonnaV:

Someone smarter can answer this....Is the probability higher that we can guess where something WILL NOT be than where something WILL be...IOW selling far OTM credit spreads we are saying the SPX will NOT be lower/higher than thus and such VS in buying a spread we are are saying the SPX WILL be thus and such.

When we BUY a spread are we not trying to be MORE precise than when we are SELLING the same spread?
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Not saying i am smarter but let me say what i think. It all translates to what YOU think the underlying WILL BE at expiration.

The decision to enter a credit spread over a debit should not be based on collecting premium vs buying premium it should be based on where you think the underlying will end up. It sounds simple but many traders i know can't grasp it fully.

You are right about being more precise with debits. The reason i prefer credit spreads on the SPX is because when i chose the right strike the underlying can end up at the strike or below it for calls and over it for puts and still make money at expiration whereas with debit spreads the underlying has to go through your long strike. But my spreads aren't as wide so, i am probably not the right person to answer this.
 
Quote from DonnaV:

Someone smarter can answer this....Is the probability higher that we can guess where something WILL NOT be than where something WILL be...IOW selling far OTM credit spreads we are saying the SPX will NOT be lower/higher than thus and such VS in buying a spread we are are saying the SPX WILL be thus and such.

When we BUY a spread are we not trying to be MORE precise than when we are SELLING the same spread?
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Donna, the odds are the same. Think about it. Perform this exercise. Try to go one month where you make a directional trade every day with the intention of being right. Then the following month make a trade every day for a month with the intention of being wrong. You will discover that it's just as hard to be consistently wrong about the market as it is to be consistently right.

The same holds true with your notion that you are betting where the market will not go. It's really infantile. That's not meant as an insult btw.

I would always get a kick out of my buddies who would bet on pro football and say it's easier to bet on the over/under then the line. I would laugh because both are the same thing. Betting on what you think the score will not be is just as hard as betting on what it will be.

And to answer your last question, no, when you buy premium you need not be any more precise then if you sell premium. Folks, why is the assumption being made here that you are holding these positions till expiration? Is this communist China?

You have no such handcuffs. Are you telling me that if you were long call spreads in the NDX and the Russell 2000 the last week you would not be selling them for a windfall profit? Most long premium traders I know are always buying and selling different combinations of options. They are not buying and waiting.

P.S Donna, stay away from Vegas. They build grand hotels from the money they make off of people that have your mentality. Most of those games in the casinos (the feel good games) are the real sucker bets. :D
 
I'm not responding to any particular post... but when comparing option's odds/fair value to gambling...
Look at the football spread and especially at the opening line. Here the house (MM) have relatively easy task : only two teams, only one number to post , spread like 3 , 7 and 10 are different that any other numbers and some few other nuances. How many times they were wrong ? How many times they needed to move the line because public unevenly placed the bets ? And by the end they making money because of build in edge of 4.5% (bid/ask?) 21/22 .
So now... its very difficult for me to belive that MM can perfectly place a fair value for 2500 stocks times tens of strakes times different months ...and keep this perfection for EVERY minute with ANY change in stock price.
 
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