SPX Credit Spread Trader

[domestic]

Quote from rallymode:

Well thats a bit one sided. While i concur with your assessment that a position should be evaluated on the fly and kept open only if the current risk/reward is in line with personal expectations, i disagree that initial credit is "immaterial". Perhaps, i am reading you wrong but i will make this point anyway.

It seems this whole discussion started when someone said how they were comfortable with a position which is closer to the market yet suggested that another poster be careful with theirs which was farther away. Mark, you of all people should know better and the answer is gamma. A prudent risk manager who sells peak gamma isn't and shouldn't be as concerned as someone who has sold against the upside slope. One of the reasons for selling fat gamma is just that, the feasibility of management. The initial credit received is a direct result of the type of curvature you have sold, so saying it is immaterial is like saying it doesn't matter whether you sold cheap or expensive gamma.

didn't mean to interrupt, just thought i'd throw in my 2 cents.

rally, is the bulk of your trading ctm? do you hedge with any long options; or just exit a trade that you decide is not profitable?

as i trade er2, if i was 20 or 30 point out with what was a fat gamma trade and the the market moves 16pts toward my short in one or two days; what course of action would you do?

i currently have shorts at feb 695....but of course i'd like to study other options(couldn't resist).

also, is your background professionally based? i just find it interesting to know if you do not mind.

 

[dagnyt]

Quote from rallymode:

Well thats a bit one sided. While i concur with your assessment that a position should be evaluated on the fly and kept open only if the current risk/reward is in line with personal expectations, i disagree that initial credit is "immaterial". Perhaps, i am reading you wrong but i will make this point anyway.

It seems this whole discussion started when someone said how they were comfortable with a position which is closer to the market yet suggested that another poster be careful with theirs which was farther away. Mark, you of all people should know better and the answer is gamma. A prudent risk manager who sells peak gamma isnt and shouldnt be as concerned as someone who has sold against the upside slope. One of the reasons for selling fat gamma is just that, the feasibility of management. The initial credit received is a direct result of the type of curvature you have sold, so saying it is immaterial is like saying it doesnt matter whether you sold cheap or expensive gamma.

Didnt mean to interrupt, just thought i'd throw in my 2 cents.

Hi Rally,

I think you and I are in total agreement.

Sure, the initial credit received is important - but IMHO, it's only important in deciding whether or not to open the position. My disucssion is based on the assumption that the "to open or not to open" decision has already been made. Once I own a position, there is nothing I can do about the initial credit or how much I have made (or lost) so far on that position. I believe that the decision to adjust, close, or hold is not related in any way to that initial credit.

Regarding 'fat gamma': It stands to reason that a spread that is CTM will be sold for a much higher credit than a spread that is FOTM. Greater risk means greater rewards. It also means more skill is required in managing the position (a point often overlooked). My point is that whether one collects $4, $2, or $1 for a given spread, managing risk and deciding whether to adjust, hold, or close should not be based on that credit. N'est pas?

Mark

 

[andysmith]

I didn't state explicitly, but I meant the R/R at the point of opening the trade. I think the pros look at R/R on a daily basis (i.e. marked to market) and manage risk that way... never letting any one trade or total portfolio risk exceed certain thresholds.

Quote from dagnyt:

That viewpoint represents the thinking of the vast majority of traders and is 100% incorrect.
Consider this: You open a credit spread for $2 and some time passes. Let's say that you can now close the position for a 40 cent debit. You have a choice: keep this spread open or close it.

Do you make your decision to close (or not to close) based on the initial credit? Would you close had you received a $4 initially but not if you collected only $2?

If you say the credit matters, you have a common blind spot. In the scenario above, you own a position TODAY and must decide if you want to maintain the position in an attempt to earn all, or part, of the remaining 40 cents. That's the choice. TODAY 40 cents remains. That's the most you can earn from this point forward. What you gained (or lost) to date is immaterial. You must decide if it's worth holding based on the likelihood of earning additional profits and the risk involved in trying to collect that profit. Some traders (me, for example) also weigh the profit potential from this spread vs. the profit potential (and risk) of another spread that could be opened if margin were freed up by closing the current position.


You speak of adjustments. If a hedge is needed to minimize risk, then it's needed. It has nothing to do with the credit collected when opening the trade. Are you telling me that you would not hedge a spread just because you collected a smaller premium when you initiated the position, but would do so if the initial credit were larger? That's saying there is too little proft in one position, so you cannot afford to hedge. Do you just shut your eyes and hope for the best? I hope not, for that's an absurd way to manage risk.

Mark

 

[rallymode]

Quote from dagnyt:

Hi Rally,

I think you and I are in total agreement.

Sure, the initial credit received is important - but IMHO, it's only important in deciding whether or not to open the position. My disucssion is based on the assumption that the "to open or not to open" decision has already been made. Once I own a position, there is nothing I can do about the initial credit or how much I have made (or lost) so far on that position. I believe that the decision to adjust, close, or hold is not related in any way to that initial credit.
How can you say once the position is on, the initial credit is irrelevant when it dictates the r/r until offset? Say i sold an ATM vertical at 1:1 r/r vs someone selling a FOTM vertical at 10:1 r/r do you honestly think that this is irrelevant to how/when it is adjusted/offset after the position has gone say 2 points against both traders?


Regarding 'fat gamma': It stands to reason that a spread that is CTM will be sold for a much higher credit than a spread that is FOTM. Greater risk means greater rewards. It also means more skill is required in managing the position (a point often overlooked). My point is that whether one collects $4, $2, or $1 for a given spread, managing risk and deciding whether to adjust, hold, or close should not be based on that credit. N'est pas?
I wouldnt necessarily say you need more skill to manage peak gamma. In fact, i believe even the best trader will have a very hard time managing cheap gamma that has gone against them. Also, why is peak gamma greater risk? No, i think it is rather a lower probability. The high probability trades are where the great risk lies IMO. As far as the credit being important, it is only important as it affects the risk/reward ratio of the position. I dont endorse trading for a certain number of monthly/weekly points gained but rather risk allocated. With that in mind, the credit continues to matter until you are out of the position. I think we arguing semantics though, i just dont see how the credit ceases to matter as soon as you see the fill in your account.
Mark

 

[rallymode]

Quote from domestic:

rally, is the bulk of your trading ctm? do you hedge with any long options; or just exit a trade that you decide is not profitable?
yes, most of my stuff is done within 30 deltas on the sell side.

as i trade er2, if i was 20 or 30 point out with what was a fat gamma trade and the the market moves 16pts toward my short in one or two days; what course of action would you do?

i currently have shorts at feb 695....but of course i'd like to study other options(couldn't resist).
i am not sure i know how to answer these types of questions as i have no idea what you based the trade on nor do i know what else has changed since the position was put on. =)

 

[dagnyt]

Quote from rallymode:

I think we arguing semantics though...

That's the bottom line and I agree.

... i just dont see how the credit ceases to matter as soon as you see the fill in your account.

It matters. It just plays no role (I know that I hold the minority viewpoint here) in deciding when/whether to adjust/hold/close.

How can you say once the position is on, the initial credit is irrelevant when it dictates the r/r until offset?

I don't agree. The initial r/r dictates profit potential, but the current r/r dictates ongoing strategy.

Say i sold an ATM vertical at 1:1 r/r vs someone selling a FOTM vertical at 10:1 r/r do you honestly think that this is irrelevant to how/when it is adjusted/offset?

No. Each of those methods requires a diffent adjustment strategy. I'm sure we agree there.

But, what i am saying that whether you open a CTM spread for $3 today or if you opened the same spread for $4 a week ago that the correct adjustment methodology is identical and is totally unrelated to that original credit.

And I'll go further. Once the position is open, a CTM spread can easily become a FOTM spread. (And a FOTM spread can easily become a CTM spread.) Now the question becomes: do you adjust this spread (if necessary) based on the fact that it was once a CTM spread? Do you adjust it based on the fact that it's now a FOTM spread? Or do you adjust it when future market conditions tell you that the then current r/r is unacceptable?

I adjust when the current condition is unsatisfactory - and the amount of cash I received when I opened the position is going to affect my final P/L, but it has zero bearing on my decision to adjust. I adjust to reduce risk.

I manage my portfolio by trying to make money each month. I DO NOT manage it by trying to make each individual trade a winner. I know that premium selling is a strategy that guarantees losses part of the time. My goal is to generate as much income (within my risk guidelines) as I can for my entire portfolio and not be concerned if individual trades are losers. That means I adjust when the position has an unacceptable r/r profile - based on it's current price.

Again, it's semantics.

Thanks for the discussion.

Mark

 

[domestic]

Quote from rallymode:

my question was not regarding m short 695's. i should not have added that.

the question referred to a hypothetical spread that was put on 20-30 otm and then then market moved 16 or so points toward the short strike. what i was interested in knowing is; what would you do if this event occurred? totally hypothetical. if you needed to know some other points regarding why the trade was put on or other issues, there are none since i made up the scenario. just want to see how you would react. maybe you have some recent management trades that are similar. again , i am interested in how you manage a trade that does not go as you predicted.

 

[andysmith]

Rally, I've been doing a few CTM spreads recently too. A question: when your spread turns out to be a bad trade (i.e. directionally incorrect), what action do you take (i.e. take the spread off, adjust, etc)?

Thanks!

Quote from rallymode:

Well thats a bit one sided. While i concur with your assessment that a position should be evaluated on the fly and kept open only if the current risk/reward is in line with personal expectations, i disagree that initial credit is "immaterial". Perhaps, i am reading you wrong but i will make this point anyway.

It seems this whole discussion started when someone said how they were comfortable with a position which is closer to the market yet suggested that another poster be careful with theirs which was farther away. Mark, you of all people should know better and the answer is gamma. A prudent risk manager who sells peak gamma isnt and shouldnt be as concerned as someone who has sold against the upside slope. One of the reasons for selling fat gamma is just that, the feasibility of management. The initial credit received is a direct result of the type of curvature you have sold, so saying it is immaterial is like saying it doesnt matter whether you sold cheap or expensive gamma.

Didnt mean to interrupt, just thought i'd throw in my 2 cents.

 

[rallymode]

domestic, andy, i would most likely close it, take the loss and wait for the next signal. I dont believe in adding expectancy to bad trades by hedging or adjusting them.

 

[andysmith]

Rally -- I agree. I have been disciplined in closing my CTM credit spreads upon hitting my stop (my stop is based on the underlying, not the spread value).

Unfortunately, it's much more painful to get stopped out of a credit spread than an equity/futures trade because of the b/a slippage on the spread. How do you overcome this disadvantage? Any advice is much appreciated.

Quote from rallymode:

domestic, andy, i would most likely close it, take the loss and wait for the next signal. I dont believe in adding expectancy to bad trades by hedging or adjusting them.