SPX Credit Spread Trader
- Thread starter El OchoCinco
- Start date
Well since someone asked what the pros did after 9/11... I'm not a pro, but I was trading options before, during, and after 9/11. So I'll throw in my two "sense" regarding the black swan protection. There seems to be a whole lot of discussion about these events, especially when you consider that they are actually quite rare. I think my take on this topic is a little bit different than most on this forum, so I'll throw it out there for everyone to criticize.
Speaking from experience I prefer the following as a "hedge" against a black swan.
1) If my main strategy involves selling premium I make sure that I am collecting as much of it as possible between the black swan events. I realize that this sounds like a really stupid comment, and everyone is thinking, "no s#_t Sherlock"! What I mean is that I prefer not to give back a significant portion of my premium to protect against something that only happens once every several years. In fact I generally don't like to give back any of the collected premium by buying a hedge.
2) Never make it possible to wipe out a huge part of my account if one trade goes bad. This is done in two ways.
First, I try to diversify. Not only by holding positions in several different issues, but by trading a few different strategies. I always make sure that some (about half) of my positions would benefit from a black swan. But I also try to make sure that these same positions will also benefit without a black swan. IOW, something like a slightly OTM bear call. Or if I'm more bearish maybe an OTM bear put.
Second, I generally trade closer to the underlying. This allows me to get the same credit without risking so much capital. The safest money during a black swan is cash. So if I've got 100K that I want to make 3% on this month, and I'm bullish on the market. I could tie up 50% of it on a 10-point FOTM bull put spread for a $0.60 credit. Or I could tie up 10% of it on a closer 5-point bull put for a $1.25 credit. I prefer the latter as the resulting gains are similar in the long run, but the latter protects me against the black swan.
Just my experience, but I think the best hedge against the black swan isn't a hedge at all.
Speaking from experience I prefer the following as a "hedge" against a black swan.
1) If my main strategy involves selling premium I make sure that I am collecting as much of it as possible between the black swan events. I realize that this sounds like a really stupid comment, and everyone is thinking, "no s#_t Sherlock"! What I mean is that I prefer not to give back a significant portion of my premium to protect against something that only happens once every several years. In fact I generally don't like to give back any of the collected premium by buying a hedge.
2) Never make it possible to wipe out a huge part of my account if one trade goes bad. This is done in two ways.
First, I try to diversify. Not only by holding positions in several different issues, but by trading a few different strategies. I always make sure that some (about half) of my positions would benefit from a black swan. But I also try to make sure that these same positions will also benefit without a black swan. IOW, something like a slightly OTM bear call. Or if I'm more bearish maybe an OTM bear put.
Second, I generally trade closer to the underlying. This allows me to get the same credit without risking so much capital. The safest money during a black swan is cash. So if I've got 100K that I want to make 3% on this month, and I'm bullish on the market. I could tie up 50% of it on a 10-point FOTM bull put spread for a $0.60 credit. Or I could tie up 10% of it on a closer 5-point bull put for a $1.25 credit. I prefer the latter as the resulting gains are similar in the long run, but the latter protects me against the black swan.
Just my experience, but I think the best hedge against the black swan isn't a hedge at all.
cache,
you hit my sentiments exactly. I said this exact same thing a month or so ago. The best black swan hedge for the FOTM credit spread seller is the hope that the credit collected between the black swans is more than the loss during each event. Not very comfortable, i know but that's the only way i see this strategy making any money over the long haul(20+ years).
Now the problem with that is when do you actually start? Wait until a black swan and then begin the strategy comes to mind.
I know this subject has been beaten to death on this thread but where the FOTM trader hedges, the OTM guy adjusts. Draw it out over time and you get the same result. Whether you go FOTM, OTM or ATM, if applied using consistent and comparable entries with equilized risk management approach, the different strategies will gain/lose the same over the long term with the exception that the black swan will most likely take the big risk taker out. They may not risk all they have in that account but for the sake of arguement that account will be blown.
you hit my sentiments exactly. I said this exact same thing a month or so ago. The best black swan hedge for the FOTM credit spread seller is the hope that the credit collected between the black swans is more than the loss during each event. Not very comfortable, i know but that's the only way i see this strategy making any money over the long haul(20+ years).
Now the problem with that is when do you actually start? Wait until a black swan and then begin the strategy comes to mind.
I know this subject has been beaten to death on this thread but where the FOTM trader hedges, the OTM guy adjusts. Draw it out over time and you get the same result. Whether you go FOTM, OTM or ATM, if applied using consistent and comparable entries with equilized risk management approach, the different strategies will gain/lose the same over the long term with the exception that the black swan will most likely take the big risk taker out. They may not risk all they have in that account but for the sake of arguement that account will be blown.
Just to clarify one aspect of this post. The "big risk taker" is the FOTM guy. Many on this thread refer to FOTM spreads as less risky because of the high probability of profit. This is essentially backwards.
Hi Murray,
Couple days ago, I tried to create may/jun put diag and found that it's difficult to create for a credit unless I make the spread very wide at least 50 points. I'd like to get a comment from you how you usually do it.
I do diag often but mostly on spy and spx and never get credit on them until rolling.
You mentioned about back testing. How did you get the data ? If they are in spreadsheet, may I get it ?
Last, I usually create my put diag when spy runs up which made the vol low. If I apply that to SPX, I guess this is not the right time to do it. What do you think ?
Thanks,
-Nick
Couple days ago, I tried to create may/jun put diag and found that it's difficult to create for a credit unless I make the spread very wide at least 50 points. I'd like to get a comment from you how you usually do it.
I do diag often but mostly on spy and spx and never get credit on them until rolling.
You mentioned about back testing. How did you get the data ? If they are in spreadsheet, may I get it ?
Last, I usually create my put diag when spy runs up which made the vol low. If I apply that to SPX, I guess this is not the right time to do it. What do you think ?
Thanks,
-Nick
I know that usually when i talk about FOTM credit spreads i come out as criticizing. It isnt that i believe the strategy cant be profitable, it's just that a person really needs to minimize the risk if they want to be successful over the long term.
For the sake of discussion i am going to throw this idea out and if any FOTM guys are willing to follow what i am saying they will hopefully benefit from it. Take it as my contribution although many may disagree, i am sure some will find it helpful and perhaps spare themselves a blown account. Because of the horrible r/r the account may still be blown nevertheless.
I always talk about trying to optimize entries and try to bring consistency into your FOTM trading but i never actually get specific and explain what in the hell i am talking about. So i figured i'd shed some light on what i believe can make a credit spread strategy work for you whether it's FOTM, OTM or ATM. I use the same principles with my close OTM spreads.
If i was forced to trade FOTM credit spreads, this is how i would trade them. This way is in no way perfect but it has consistency, optimal entries and will reduce the risk significantly.
Let's get to business.
Forget bull put spreads and forget hedges. Yes, forget everything that costs you part of your credit and intriduces unnecessary risk. The only thing i would trade is bear call spreads.
These would be the parameters of the trade:
1. I would follow the 6 month trading range of the SPX.
2. I would open front month spreads 4-5 weeks out.
3. I would only enter the trades when the SPX is at/within 5-10 points of the 3-month high. The closer the better. Which should be the short term resistance/overbought level or close to it. If i dont get my entry i SKIP a month. Market will always be here next month.
4. I would go 65-70 points OTM(5-6% should the IV increase in the future) and try to get $.5 or better on a 10-pointer. I am looking at the current price and i think this is doable and could be improved upon. NO?
5. All positions will be held through expirations with very few exceptions when SET might be a threat.
6. There will be no hedging, rolling up or out.
7. Seasonal periods characterized as periods where the market historically rallies will be avoided.
8. Hedges and rolls are the enemy. They only reduce my tiny credits and expose me to the whipsaw effect. While it might seem prudent given the horrendous r/r, it probably wont do much good in the grand scheme of things(when i have to hedge or roll twice and the market whipsaws my ass and brings me back 6 months). Hence my not liking the FOTM strategy but here i am forced to trade it.
Now here is the kicker. You need 20 months of .5 credits to double your risk money/account money. Better credits will reduce the time frame. Backtesting this strategy for the past 20 months will show a good success, but past performance is no indication of future results
Fed cuts the rates at next meeting or alternative energy source is found and your account might be blown after only .50 credits.
I hope this is helpful to some. Any comments are welcome. Just thought i'd share what i mean when i say consistency in approach.
For the sake of discussion i am going to throw this idea out and if any FOTM guys are willing to follow what i am saying they will hopefully benefit from it. Take it as my contribution although many may disagree, i am sure some will find it helpful and perhaps spare themselves a blown account. Because of the horrible r/r the account may still be blown nevertheless.
I always talk about trying to optimize entries and try to bring consistency into your FOTM trading but i never actually get specific and explain what in the hell i am talking about. So i figured i'd shed some light on what i believe can make a credit spread strategy work for you whether it's FOTM, OTM or ATM. I use the same principles with my close OTM spreads.
If i was forced to trade FOTM credit spreads, this is how i would trade them. This way is in no way perfect but it has consistency, optimal entries and will reduce the risk significantly.
Let's get to business.
Forget bull put spreads and forget hedges. Yes, forget everything that costs you part of your credit and intriduces unnecessary risk. The only thing i would trade is bear call spreads.
These would be the parameters of the trade:
1. I would follow the 6 month trading range of the SPX.
2. I would open front month spreads 4-5 weeks out.
3. I would only enter the trades when the SPX is at/within 5-10 points of the 3-month high. The closer the better. Which should be the short term resistance/overbought level or close to it. If i dont get my entry i SKIP a month. Market will always be here next month.
4. I would go 65-70 points OTM(5-6% should the IV increase in the future) and try to get $.5 or better on a 10-pointer. I am looking at the current price and i think this is doable and could be improved upon. NO?
5. All positions will be held through expirations with very few exceptions when SET might be a threat.
6. There will be no hedging, rolling up or out.
7. Seasonal periods characterized as periods where the market historically rallies will be avoided.
8. Hedges and rolls are the enemy. They only reduce my tiny credits and expose me to the whipsaw effect. While it might seem prudent given the horrendous r/r, it probably wont do much good in the grand scheme of things(when i have to hedge or roll twice and the market whipsaws my ass and brings me back 6 months). Hence my not liking the FOTM strategy but here i am forced to trade it.
Now here is the kicker. You need 20 months of .5 credits to double your risk money/account money. Better credits will reduce the time frame. Backtesting this strategy for the past 20 months will show a good success, but past performance is no indication of future results
Fed cuts the rates at next meeting or alternative energy source is found and your account might be blown after only .50 credits.
I hope this is helpful to some. Any comments are welcome. Just thought i'd share what i mean when i say consistency in approach.
this has been discussed before (but maybe not enough).....
even though i trade atm and slightly otm credit spreads mostly, i also trade these:
buy september spx 1280 put
sell may spx 1280 put
most of these trades work out fine, some do not...but i do not worry about black swan what so ever. on some occasions after i have received a couple of months of credits, i will turn these into a 5 or 10 pt trade to get more return, only after i have received much premium. sometimes i do not , and take minimal premium so as not to expose myself.
any thoughts on this strategy for it's hedging and profitability characteristics?
even though i trade atm and slightly otm credit spreads mostly, i also trade these:
buy september spx 1280 put
sell may spx 1280 put
most of these trades work out fine, some do not...but i do not worry about black swan what so ever. on some occasions after i have received a couple of months of credits, i will turn these into a 5 or 10 pt trade to get more return, only after i have received much premium. sometimes i do not , and take minimal premium so as not to expose myself.
any thoughts on this strategy for it's hedging and profitability characteristics?
A, I agree!
For the same probability in terms of moneyness, you will pay more (receive less credit) on the call side. Combination of lognormal probability models and IV skew makes for a double whammy - though one might be a reflection of the other.
For the same probability in terms of moneyness, you will pay more (receive less credit) on the call side. Combination of lognormal probability models and IV skew makes for a double whammy - though one might be a reflection of the other.
Rally:
Most of what you state is the current way I'm trading FOTM.
1) Only bear call spreads. Although those premiums on the bull puts sure look good.
2) I start putting positions on 6 to 7 weeks before expiration. Otherwise, it's tough to get $0.5 to $0.6 per 10 pt. bear call vertical that is 60 to 70 points removed on the short strike.
3) Following your earlier suggestion, I'm attempting to place positions at the top of the channel, if the SPX is trading in one.
4) Currently, I'm only hedging when it looks like the SPX will move against me, or if work prevents me from monitoring my positions for more than 1 day. In the latter case I consider closing any positions that look like they might be threatened esp. if there is major upcoming news (I had to do this in May before the FOMC meeting).
5) In the November to December time frame (historical uptrends), I'll be looking to either sit out or possibly leg in ala Donna.
6) I generally hold my bear calls until expiration, unless I'm trying to free up margin. I've been fairly successful at legging out of FOTM bear calls for no cost (other than commissions). Based on the SET spreadsheets I've been posting, I generally get out earlier (last trading day), if the SPX is within 15 points of any of my short strikes.
What your writeup is missing is the risk management plan. It looks like you're hanging on to positions unless it is the SET that threatens the position. I believe that this is a major flaw in the strategy that you outline. Much of Coach's dissertations discuss risk mgt. and closing or adjusting positions. The strategy you list has a similar "risk mgt" plan to the "close to ATM" trading style that you currently use. IMHO, this is a big mistake for FOTM credit spreads. Implement Coach's plan on the FOTM spreads and the odds of a blow out are greatly reduced over what you propose.
You mention blowing up the account, but I believe that without the risk of black swan this can be almost negated. I generally follow Coach's risk mgt. plan (which is well documented on this thread), but have no trouble just closing the position and moving on to the next month. Another strategy is to just close any positions where the current cost to buy back the vertical is twice the credit received. The key is not to get married to positions and to realize that there is always next month; but, you have to stay in the game.
Once you actually blow a large amount of money, it's not too hard to give up a thousand or two of credit just to remain in the game (your whole perspective changes).
IMHO, the thing that gets many of us (myself included) in trouble, is the insistence to "hang on to that credit" or "I have to make $XXXXX dollars per month". This attitude was one of the things that really killed me. Still, the month-after-month credit can become addictive, so it's a constant battle to fight this attitude.
Most of what you state is the current way I'm trading FOTM.
1) Only bear call spreads. Although those premiums on the bull puts sure look good.
2) I start putting positions on 6 to 7 weeks before expiration. Otherwise, it's tough to get $0.5 to $0.6 per 10 pt. bear call vertical that is 60 to 70 points removed on the short strike.
3) Following your earlier suggestion, I'm attempting to place positions at the top of the channel, if the SPX is trading in one.
4) Currently, I'm only hedging when it looks like the SPX will move against me, or if work prevents me from monitoring my positions for more than 1 day. In the latter case I consider closing any positions that look like they might be threatened esp. if there is major upcoming news (I had to do this in May before the FOMC meeting).
5) In the November to December time frame (historical uptrends), I'll be looking to either sit out or possibly leg in ala Donna.
6) I generally hold my bear calls until expiration, unless I'm trying to free up margin. I've been fairly successful at legging out of FOTM bear calls for no cost (other than commissions). Based on the SET spreadsheets I've been posting, I generally get out earlier (last trading day), if the SPX is within 15 points of any of my short strikes.
What your writeup is missing is the risk management plan. It looks like you're hanging on to positions unless it is the SET that threatens the position. I believe that this is a major flaw in the strategy that you outline. Much of Coach's dissertations discuss risk mgt. and closing or adjusting positions. The strategy you list has a similar "risk mgt" plan to the "close to ATM" trading style that you currently use. IMHO, this is a big mistake for FOTM credit spreads. Implement Coach's plan on the FOTM spreads and the odds of a blow out are greatly reduced over what you propose.
You mention blowing up the account, but I believe that without the risk of black swan this can be almost negated. I generally follow Coach's risk mgt. plan (which is well documented on this thread), but have no trouble just closing the position and moving on to the next month. Another strategy is to just close any positions where the current cost to buy back the vertical is twice the credit received. The key is not to get married to positions and to realize that there is always next month; but, you have to stay in the game.
Once you actually blow a large amount of money, it's not too hard to give up a thousand or two of credit just to remain in the game (your whole perspective changes).
IMHO, the thing that gets many of us (myself included) in trouble, is the insistence to "hang on to that credit" or "I have to make $XXXXX dollars per month". This attitude was one of the things that really killed me. Still, the month-after-month credit can become addictive, so it's a constant battle to fight this attitude.