SPX Credit Spread Trader

[lar]

Sounds good Phil,

One more question please, then - I'll try to sit back, watch and learn.

IV is pretty high in the S&P (relative to it's 6 month range) right now. Do you prefer these OOM credit spreads in a high implied volatility environment? Do you use the same parameters in a low IV environment?

Thanks again for helping to enlighten me in an area I've been bursting to explore more fully.

Peace and gtty,

Lar

 

[El OchoCinco]

Given the nice IV skews you get in the OTM puts in SPX, I like trading in all volatilities. I am not looking for IV expansion or contractions, just time decay and worthless spreads at expiration. Higher IV lets me get better fills on the call side where the skew works against you.

Phil

 

[EliteThink]

Phil, what is your mathematical expectancy? Surely it is better than .05*91500 + .95*4500 which equals a loss of more than $200 per trade.

 

[SteveL91]

Interesting thread, and something I've been considering for a while. I'll also be watching this journal with interest.

I did have a question: Do you primarily write bull put spreads? I'd imagine that with this sort of risk profile, you'd want to stay away from bear call spreads just because it (seems) more likely for the indices to make huge moves downwards against you than up.

Thanks,
Steve

 

[SteveL91]

Quote from SteveL91:

Interesting thread, and something I've been considering for a while. I'll also be watching this journal with interest.

I did have a question: Do you primarily write bull put spreads? I'd imagine that with this sort of risk profile, you'd want to stay away from bear call spreads just because it (seems) more likely for the indices to make huge moves downwards against you than up.

Thanks,
Steve

Ugh. I screwed up. I meant to say that I'd imagine you'd want to avoid bull put spreads with this type of risk profile.

 

[El OchoCinco]

Mathematical expectancy is a nice formula but it is not realistic. I will never take the full $91,500 loss given my risk management plan. Given the movement of the index it would be hard to imagine anyone truly sitting there and taking the full $91,500 loss. So I do not go by straightforward statistical expectancy. Expectancy is not what is most importance to me, actual money making is. As I said, the whole key to this strategy is risk management and allowing this position to get to the maximum loss is not something that should be considered.

The odds of the strikes being in the money is extremely small. WIth an index, the movement will not be a gap down overnight so I do not have to worry about going to bed with the index at 1130 and waking up at 1070. The key is in the way I approach the trades. I plan to roll out if I am within 10 points of my short strike. Given time decay the potential loss in such an approach is far far less than $91,500, especially since the options will not even be in the money when I roll out.

Moreover, the occurrences where the market has made such a large move in 35 days or less is extremely rare and at most once a year (9/11 is the extreme movement and that was 13% or so in a month. The other extreme was about 10% and it took 4 weeks to make that move).

Moreover, when the market starts moving towards my short strikes, I add partial hedges in place using options on futures and SPY options. THis reduces the potential profit but that is the price of insurance. I do not mind reducing a 5% profit to a 2.5% profit if it gives me more cushion. That is still pretty good for 35 days or so. So when I have to pull out at the extreme, my hedge profits reduce the loss somewhat to a smaller loss. The annual chances of losses on 10 positions is about 2 out of 10 during sever market activity. Following my own personal risk management plan, I can still have positive returns with 2 out of 10 positions where I was forced to close out my spreads.

So I do not use the general expectancy since it involves the unrealistic assumption that I would lose the full $91,500. For example, assume 1 approache to this stategy is to get out when the cost to close the spread is 10% of the margin. In that case it would be 5% of $9,150 v. 95% of $4,500 which is a postive cash expectancy per trade. It is easy to play with these numbers. That is why I focus on the risk management plan and actual trading.

I appreciate the question!

Regards,

Phil

Quote from EliteThink:

Phil, what is your mathematical expectancy? Surely it is better than .05*91500 + .95*4500 which equals a loss of more than $200 per trade.

 

[El OchoCinco]

I primarily wirte bull put spreads due to the generous IV skew in S& P index options. This allows me to go further out of the money, have a greater cushion and in some way reduce my risk. In a market like today it is more likely for the market to trend sideways, or move slightly higher or lower month to month. THis is a perfect market for selling credit spreads and I go with the puts for the IV skew.

I do add call credit spreads based on swings in the S&P. For example, in May after the large run up in the S&P to 1175 or so a few weeks ago, I sold the MAY 1200/1220 bear call spread. So I had a large position in a bull put spread and added the bear call spread later on. I like adding different strike spreads as the month progresses to add mroe income possibilities. Another example is on MOnday I sold a 1125/1110 bull put spread on the SPX for $0.35 to collect this little morsel the last week of expiration given the low chance the market would drop from its then levels of 1160 to 1125 in 4 days (SPX options expire on Thursday).

So my approach changes month to month and by putting it here, you can follow along the differnt trades.

Look forward to the road ahead!

Phil

Quote from SteveL91:

Interesting thread, and something I've been considering for a while. I'll also be watching this journal with interest.

I did have a question: Do you primarily write bull put spreads? I'd imagine that with this sort of risk profile, you'd want to stay away from bear call spreads just because it (seems) more likely for the indices to make huge moves downwards against you than up.

Thanks,
Steve

 

[just21]

Isn't options expiry on saturday morning? I see from the calendar that AM index options expire on thursday. What are they?

 

[AAAintheBeltway]

Quote from optioncoach:

Mathematical expectancy is a nice formula but it is not realistic. I will never take the full $91,500 loss given my risk management plan. Given the movement of the index it would be hard to imagine anyone truly sitting there and taking the full $91,500 loss. So I do not go by straightforward statistical expectancy. Expectancy is not what is most importance to me, actual money making is. As I said, the whole key to this strategy is risk management and allowing this position to get to the maximum loss is not something that should be considered.

The odds of the strikes being in the money is extremely small. WIth an index, the movement will not be a gap down overnight so I do not have to worry about going to bed with the index at 1130 and waking up at 1070. The key is in the way I approach the trades. I plan to roll out if I am within 10 points of my short strike. Given time decay the potential loss in such an approach is far far less than $91,500, especially since the options will not even be in the money when I roll out.

Moreover, the occurrences where the market has made such a large move in 35 days or less is extremely rare and at most once a year (9/11 is the extreme movement and that was 13% or so in a month. The other extreme was about 10% and it took 4 weeks to make that move).

Moreover, when the market starts moving towards my short strikes, I add partial hedges in place using options on futures and SPY options. THis reduces the potential profit but that is the price of insurance. I do not mind reducing a 5% profit to a 2.5% profit if it gives me more cushion. That is still pretty good for 35 days or so. So when I have to pull out at the extreme, my hedge profits reduce the loss somewhat to a smaller loss. The annual chances of losses on 10 positions is about 2 out of 10 during sever market activity. Following my own personal risk management plan, I can still have positive returns with 2 out of 10 positions where I was forced to close out my spreads.

So I do not use the general expectancy since it involves the unrealistic assumption that I would lose the full $91,500. For example, assume 1 approache to this stategy is to get out when the cost to close the spread is 10% of the margin. In that case it would be 5% of $9,150 v. 95% of $4,500 which is a postive cash expectancy per trade. It is easy to play with these numbers. That is why I focus on the risk management plan and actual trading.

I appreciate the question!

Regards,

Phil

Anyone contemplating this might want to read Taleb first. Lot of smart guys were carried out feet first who were sure their short strikes wouldn't be hit, and even if they were they could hedge on the way down. Vic Neiderhofer comes to mind.

The point is not that selling premium is a bad idea. It's that you have to plan around your max exposure. Never put on a trade that can take you out if you get a black swan event. The problem with picking up nickles and dimes is that there is a temptation to pick up too many of them at a time.

 

[El OchoCinco]

I fully understand the risk and am not new to this. As I said, it all comes down to risk management. If you fail at risk managment then you will be carried out on your shield no doubt. Most people get killed due to ego and go for quarters and dollars. I have very little ego when it comes to trading and more than willing to take the occasional lose to protect my capital and profits. My goal is to make money, NOT win 100% of the time. THis is the approach you need to most strategies. Win more often than you lose and use good risk management to limit those losses.

Indexes are not subject to the same wild price swings as individual stocks and it is easier to make a risk management adjustment on these positions then, say on GOOG which could obliterate overnight on some bad news.

This strategy is not for everyone since it takes strong will to stick to a risk management plan. I do not recommend it to people unless they are willing to put the time and effort into it.

Hope everyone follows along!

Phil