Firstly, lets acknowledge that the God of probability is probably (pun intended) as much a false idol as the God of TA. You may indeed worship both or neither. However, you have to make decisions based on something.
Secondly, I'm pretty sure I know what you're asking but before we spawn an unnecessary debate amongst others, let's assume that the markets for SPX options are efficient and that an option's price is pretty representative of it's fair value at any given moment i.e. it is not cheap or expensive. Extrapolate for spreads.
Now, to answer your question. Rightly or wrongly I simply look at it like this:
For spreads with 90% chance of success I want to be able to make enough money 9 times out of 10 to cover the one time in 10 I'm going to lose. Yes, you might be able to mitigate the loss that one time in ten but I prefer to assume worst case scenarios.
What this means in simple terms for example is getting a minimum 10% return on margin (11.1'% return on risk) for a 5 point spread that has 90% chance of expiring OTM. e.g. 1 lot example for 5 point spread:
.50 for 5 point spread.
9 times win $50 credit
1 time lose $450 max risk.
Net outcome after everything is $0 - fair enough, it was fun along the way!
I personally don't go for anything less. If you can, you should obviously go for more, because in reality commissions make the picture even worse. Again, this is just what seems like common sense to me and I'm aware that others may not be as aggressive or worried about the ROI as long as they are far enough OTM.
Is this possible? Yes. If you put on the spreads far enough out in time you will find spreads that meet this criteria but they disappear quickly once you are down to about 34/35 days out. Depends on the index and other variables.
e.g. right now, 38 days out from December the XEO DEC 540/535 bull put is marked at .50 with just over a 90% prob of expiring OTM.
This fits the criteria but you might not get filled at .50. Yesterday, it was hitting .60 with about the same probability.
You won't find it so easy going on the call side for obvious reasons.
Now, not wanting to incite a riot or anything
but I have never been able to achieve this on the SPX after slippage and as a result, amongst (many) other reasons, I do not trade the SPX. Other people may have better luck and the situation may well have changed. I realise this is the SPX credit spread trader thread!
You will most likely only find these characteristics on the narrower spreads e.g. 5 points on the XEO, 2.5 points on MNX, 1 point on QQQQ etc. and that is where commission considerations really come in.
I generally will only go as narrow as 5 point spreads which is the minimum on XEO as commission is a killer to go narrower.
It's important one understands all of the pros and cons of a 5 point spread vs. wider spreads. They have quite different characteristics. So make an informed decision. For me, the benefit of the ROI targets I can achieve, outweighs the cons of 5 point spreads on the XEO.
Lastly, yes, the index, probabilities and prices are moving all of the time but you have to have faith that at the time you place the order that the price and probability are as accurate as you can get them...and then forget about it. If 5 minutes later the probability has increased 5% well, so be it. The passage of time has occured and the probability is now different. Prices and probabilities fluctuate a lot more the closer you get to expiration because they are that more sensitive to the movement of the index, the slope becomes steeper if you like, if they are close enough ATM to be on the slope, so if you are looking at Novembers options that is what you'll see.
Good luck.
Momoney.
Quote from chrdso:
Thanks Momoney.
Looking at probability and amount to expect from a spread is interesting. (Before, I just looked at support/resistence and kept the delta of the sold option (<.15))
Do you ever see prices where you can get a fair amount based on probability? i.e 1.1 for 22% probability on a 5 spread? When the index moves probabilities change and also prices. So how do you figure if a spread is expensive or cheap? i.e. you are getting a fair/good price.
Thanks
