SPX Credit Spread Trader

[El OchoCinco]

I cannot see how the SPX will close at 1241 and then gap to 1180. We have to look at the spread in context. The SPX is at 1241 right now and we have 4 trading days to expiration. Also I can use E-mini futures which in an emergency I can short to cushion the blow while I roll out of my short put spreads. E-minis trade non-stop so even if the market is closed I can begin hedging. I do not mind taking a loss when I have too. Making 5% a month or so means even taking a limited loss 2x a year allows me to earn my return goals.

Selling straddles/strangles is so much riskier than what I am doing so I cannot advocate that. The margin requirements are so much higher and the return could be much less. Also, credit spreads allow me to put my capital elsewhere while the I believe margin requirements of naked straddles locks up that cash ( I could be wrong).

I appreciate your comments, but we just trade this differently. As long as we both make money, it does not really matter lol.

Phil

Quote from smilingsynic:

If the SPX somehow gaps to 1180, the earlier, now closed, spread is still a (small) winner, but the new spread is a huge loser. It is unlikely, but no one knows the future--it certainly can happen in a short period of time.

Gap risk is certainly the biggest danger to (bear call/bull put credit) spreads. One gap can easily wipe out many months of profits.

At least if one sells straddles or options closed to the current price of SPX, the higher premium received will at least help cushion the losses. Getting only $15 bucks a spread while leaving yourself open to a loss many, many times that seems dangerous to me.

Not with my money.

 

[El OchoCinco]

Andy:

Strangles have higher margin requirements than spreads and credit spreads allow you to obligate your money elsewhere and make money elsewhere while collecting premiums. naked strangles also have unlimited risks. Although an index has less volatile moves than a stock which can gap, you will still take on losses much greater than I will with my spreads.

Except for shorting E-minis, I avoid naked positions when I can (sounded a lot dirtier than I meant it).

Phil

Quote from andysmith:

Phil,

Great job managing risk on Friday.

You wrote "The market maker is making money on every single trade I do from the bid/ask no matter what I do."
I've been comparing naked puts/calls (i.e. selling a strangle) to selling an iron condor and your comment is one of several reasons why selling a stangle might make sense.

If one has solid, disciplined risk management then why not sell a strangle?

 

[smilingsynic]

Quote from optioncoach:

I cannot see how the SPX will close at 1241 and then gap to 1180.
Phil

If it were impossible for the market to trade at 1180, the market maker never would have bid on the options you sold.

Unlikely, yes. Very unlikely, yes. But no one knows the future. Just because you cannot see, does not meant that it will not happen.

 

[smilingsynic]

Quote from MTE:

Actually I was referring to selling straddles/strangles not credit spreads.

You have a much bigger risk with short straddles/strangles than with spreads. In a spread your risk is limited no matter what and while a huge gap can wipe out months of profits, that same gap in a short straddle/strangle can blow out your account.

If one is selling X number of atm straddles and selling X number of credit spreads, then, yes, the risk is much less with credit spreads. The problem is with credit spreads is that some get way carried away and end up with way too many. Selling one straddle, in that way, would entail much less gamma risk than selling, say, several otm options, and several more otm credit spreads.

Selling straddles is risky, sure, but at least one is not selling cheap gamma. Getting a dime and a nickel for $14.85 in risk--that to me is way too little reward for the risk it entails. At least when one sells options closer to the underlying, one is getting rewarded for the risk being taken.

When I sell straddles, I tend to leg into iron butterflies as soon as I can turn it into a risk free position.

 

[El OchoCinco]

Your points are valid but you have to realize that I also to look at probabilities of success. Selling a credit spread 50 points OTM with 30 days to expiration has a high probability of expiring worthless. No matter what the gamma is, I have a long option and a short option which partially offset to result in a small net positive. I have a good chance of success 10 out of 12 months and my approach limits my loss in those 1 or 2 months such that I make a significant return.

Every strategy has its own risks. Selling ATM straddles has vega risk and delta risk. Naturally you are free to compare selling 1 straddle v. selling 100 credit spreads as less risky but that is really apples and oranges. Selling 1 credit spread is also less riskier than selling 10 spreads. Straddles and credit spreads are two different strategies.

I do not understand why you do not feel I am getting rewarded for the risk i am taking. I think the Journal details the rewards I am getting and I can take partial loss on any spread and still have significant returns.

You are offering me your viewpoint about what is enough reward for the risk being taken and we all have our own opinion on what is an appropriate risk/reward ratio but in the end it is a personal approach. I find 5% a month to be quite rewarding and I find the risk to be quite low overall. I do not sell spreads for $0.05 or for $0.10. My recent trade was rolling up and hoping to take in more credit but the market moved away from me and I got $0.15. it is money so I will take it.

I make money. You make money. There is a difference between saying "Your approach is not right for me" and saying "Your approach is not right".

You defintiely will not convince me that I should be selling ATM straddles when I am making money this way, and have been for a long time. ATM straddles are even riskier than my positions in my opinion. If you assume that you are being rewarded for that risk, then I also feel I am being reward for the risks I am taking. If the market tanks, I can still make money while the ATM straddle could post significant losses. If you can manage the risks, then that is all the really matters. If the risks are not worth it for you in doing OTM credit spreads, then I completely understand. But if your goal is to try and convince me that my strategies do not work, well....

So if the discussion is to explore different approaches to managing this risk on THIS strategy, then I truly welcome it and it is one of the reasons I started the Journal. I am not asking you to follow my footsteps if it is a path you choose not to.


Phil

Quote from smilingsynic:

If one is selling X number of atm straddles and selling X number of credit spreads, then, yes, the risk is much less with credit spreads. The problem is with credit spreads is that some get way carried away and end up with way too many. Selling one straddle, in that way, would entail much less gamma risk than selling, say, several otm options, and several more otm credit spreads.

Selling straddles is risky, sure, but at least one is not selling cheap gamma. Getting a dime and a nickel for $14.85 in risk--that to me is way too little reward for the risk it entails. At least when one sells options closer to the underlying, one is getting rewarded for the risk being taken.

When I sell straddles, I tend to leg into iron butterflies as soon as I can turn it into a risk free position.

 

[smilingsynic]

Quote from optioncoach:

I do not understand why you do not feel I am getting rewarded for the risk i am taking.

I was referring to the paying 25 cents to buy back a deep, deep otm spread and then getting 15 cents back to sell a spread that was less otm. You lost ten cents a spread (before commissions) and now have a more risky (but still low risk) spread.

I think this is obvious.

 

[smilingsynic]

Quote from optioncoach:

I have a good chance of success 10 out of 12 months and my approach limits my loss in those 1 or 2 months such that I make a significant return.
Phil

Past profits have little to do with future returns--you should know that. Your 5% returns are based on the width of the strikes. One major loss, and you could easily be out 75% of that base. If that major loss happens to be the first one out of the gate for some greenhorn, then those 5% returns will not be realized, or, if they are, they will be on a much, much smaller base.

I'll put it this way: I have read this journal for some time, and I think you underestimate the (gap, negative gamma) risks and do not talk nearly enough about hedging (buying ES or SP futures, buying delta).

I don't like seeing good people lose good money. You or anyone else.
Anyway, take care.

 

[ckor30]

Coach, I don't know about all brokers, but the ones I trade with, do not pay interest on balance, I suppose OX neither. If you target +/- 20% per year it wouldn't be bad to squeeze 3-5% more.
How do you invest the money that you have there for margin?
Thanks

Quote from optioncoach:

Andy:

Strangles have higher margin requirements than spreads and credit spreads allow you to obligate your money elsewhere and make money elsewhere while collecting premiums.
Phil

 

[sle]

Phil,

I found your strategy interesting from a market-maker point of view. Couple of questions:

Do you ever consider constructing bull spreads out of ITM calls (equivalent to OTM put spread)?

When selecting the strikes, are you only looking at historical distribution (probability cones of some sort) or do you also take into account deltas (read - implied vols)?

Also, do you ever manage delta risk with underlying or you always buy additional options?

 

[El OchoCinco]

I appreciate your comments but you are talking in theory and I am applying practical experience. 5% returns are based on my targets not on the width of my strikes. My profit goal is 5% a month. People can choose a more agressive profit target or a more conservative target. One major loss will have no affect on my portfolio because I do not have 100% of my money in this strategy and due to the way the indexes move, I can take a partial loss and get out if the market is collapsing or rocketing. With a spread I get a partial hedge. You cannot just say that it would wipe out 75% of my base, I am speaking from experience, even with losses.

I say again and again that the secret to this position is managing the risk. If someone suffers a major loss, then they did not manage the risk correctly. This Journal has talked about making adjustments 10, 15 or even 20 points away from the short strike. The index is not going to gap 30 points, even after 9/11 it did not gap so much and post-9-11 changes have ensured the market would not shut down a week as it did then. If you cannot manage the risk effectively, then you cannot trade this or any strategy effectively.

As for greenhorns, I cannot find anyplace where I recommend this strategy to beginners. This is an advanced strategy. Even if an advanced trader has a limited loss in January, they can still have positive returns at the end of the year.

I do not underestimate any risks in this strategy. Delta and gamma are partially offset thanks to doing the spreads. Gap risks are not the same as with individual stocks. I have traded a long time and you cannot ssume I underestimate anything. AS for discussing hedging using ES or futures, I have not had to do either all year long so the actual use of them has not come up. I have discussed the use of SPYs as partial hedges in great detail.

I appreciate your concern about not losing money but I have been trading a long time and have seen up and down times. I understand the unpredictability of the market and work every day to control and manage my risk. My porfolio is not 100% in spreads and this diversification means I will never blow up my account like many hedge funds do.

Again, I appreciate your comments and welcome them. I do not underestimate any risks and monitor everything day in and day out. This is not for beginners by any means and this forum is so others can follow on my dime and learn.

best of luck...

Phil

Quote from smilingsynic:

Past profits have little to do with future returns--you should know that. Your 5% returns are based on the width of the strikes. One major loss, and you could easily be out 75% of that base. If that major loss happens to be the first one out of the gate for some greenhorn, then those 5% returns will not be realized, or, if they are, they will be on a much, much smaller base.

I'll put it this way: I have read this journal for some time, and I think you underestimate the (gap, negative gamma) risks and do not talk nearly enough about hedging (buying ES or SP futures, buying delta).

I don't like seeing good people lose good money. You or anyone else.
Anyway, take care.