Trading vertical spreads...Large order sizes with small open interest?

U

user83248324

Hi guys,

I have just began learning about vertical spreads, and have done a little paper trading with them. I am wondering though if I trade something like 100 vertical call spreads(buy 100, sell 100) and I am looking to just hold them for a day, do I have to be worried if there is very little relative open interest in the options (i.e. 1,000 open interest on each strike)? If I understand options correctly wouldn't I be holding 10% of the strike options in the market and wouldn't it be hard to unload them, or I am not understanding this correctly. Thanks alot for any help you can provide.
 
Yes, from just looking at it from the last minute it appears both options(currently one strike and two strikes above ITM) maintain a bid size of 75-100, and at the normal peaks I would maybe see 150s and at the normal lows I would see 50. And at the extreme low I saw maybe 10-30 (only a couple of times). So, this would led me to believe that trading large contracts of 100 on both ends would not be a problem then? Also I am not sure if Thinkorswims paper trading platform is totally true to life, but at times I would have a vertical spread hit my limit sell or limit buy and it would not be bought or sold, hopefully this would be because the bid size wasn't there as you pointed out and I therefore have been trading as if it was real...Maybe someone knows whether this hypothesis is correct? Thanks again.
 
Quote from user83248324:

Hi guys,

I have just began learning about vertical spreads, and have done a little paper trading with them. I am wondering though if I trade something like 100 vertical call spreads(buy 100, sell 100) and I am looking to just hold them for a day, do I have to be worried if there is very little relative open interest in the options (i.e. 1,000 open interest on each strike)? If I understand options correctly wouldn't I be holding 10% of the strike options in the market and wouldn't it be hard to unload them, or I am not understanding this correctly. Thanks alot for any help you can provide.
More...

A) Forget about holding verticals for a day, if you want to hold something for only a day, then using verticals is a very bad choice.

B)If there is little open interest, be careful, you might end up using stocks ( creating synthetics) to get out of the position unless you are prepared to get screwed. Everything is relative, but once you start trading larger size relative to open interest, be prepared for trouble. Paper trading options and getting “filled” with actual spread orders are two entirely different things. Start trading with 1 lot, forget about 100 lots. I think there are much easier ways to make money in options than the way you're proposing.

All the best
:)
 
Quote from user83248324:

Yes, from just looking at it from the last minute it appears both options(currently one strike and two strikes above ITM) maintain a bid size of 75-100, and at the normal peaks I would maybe see 150s and at the normal lows I would see 50. And at the extreme low I saw maybe 10-30 (only a couple of times). So, this would led me to believe that trading large contracts of 100 on both ends would not be a problem then? Also I am not sure if Thinkorswims paper trading platform is totally true to life, but at times I would have a vertical spread hit my limit sell or limit buy and it would not be bought or sold, hopefully this would be because the bid size wasn't there as you pointed out and I therefore have been trading as if it was real...Maybe someone knows whether this hypothesis is correct? Thanks again.
More...

1) Vertical spreads are NOT designed for a one-day holding period. You must remember that you have a bid-ask differential on each option in the spread. Then you are buying each and selling each twice. That's 4 of those nasties to overcome. This doesn't happen in one day.

Although the above is true, be ABSOLUTELY CERTAIN that you do not pay the offering price, nor sell at the bid price. Try to buy and sell near the midpoint of the bid/ask.

Enter your order as a spread, not as two separate transactions.

2) Vertical spreads, as a rule, have a small delta. That means they do not change that much when the underlying asset moves a point or two. This also suggests a longer holding period.

3) TOS paper trading is not true to life - or so I am told. You get filled MUCH more easily with play money on their system.

4) In the real world, you would get a partial fill (sometimes even a one-lot) if that's all that can be filled at a given point in time. The point is: if the market reaches your limit price, you will make a trade. It will be a fill or a partial - unless you choose 'all or none.'

Mark
http://blog.mdwoptions.com/options_for_rookies/
 
OK, thanks for the replies guys. I had been essentially scalping vertical spreads. If I would see the vertical spread that I had chosen for the day (priced in the .75 to 1.25 range) go down by about 15-20 cents quickly without the underlying moving(this happened quite frequently with the stocks I was using), I would buy in quick and then sell on the usually quick rebound back up. Taking in TOS's .95 cent per options commissions, I was still doing very while on just about every trade. Seemed to be a great system in paper trading, but of course it appears in the real world it won't work. Ha, well back to the drawing board.
 
Quote from user83248324:

OK, thanks for the replies guys. I had been essentially scalping vertical spreads. If I would see the vertical spread that I had chosen for the day (priced in the .75 to 1.25 range) go down by about 15-20 cents quickly without the underlying moving(this happened quite frequently with the stocks I was using), I would buy in quick and then sell on the usually quick rebound back up. Taking in TOS's .95 cent per options commissions, I was still doing very while on just about every trade. Seemed to be a great system in paper trading, but of course it appears in the real world it won't work. Ha, well back to the drawing board.
More...

15-20 cents on a vertical in "illiquid" options!? That's likely to be the bid-ask spread one way so it's double that round turn, so I'm not really sure how you can make money on this, but, hey, if it works for you (once you trade with real money!) then who am I to say otherwise.
 
OK, well I am not sure if 1,000 open interest is illiquid for an option or not, but if it is then yes I am getting those spreads on an illiquid option. I basically stumbled upon this as I was just doing practice vertical trades and found it interesting how I would sometimes be winning or losing on both sides of the trade at the same time...usually when this would happen one of the sides would end up going back to positive in a minute or so and even the trade back out. So after seeing this I thought isn't there someone this could be utilized? And it turned out it could and it would be profitable, but I guess it turns out that because of the small amount of options being traded that this system wouldn't really work with real money. Now when I tried to use this on SPY I was not able to due to the near ITM spreads only moving in penny increments, with the options I was trading before the near ITM options were moving in 5 cent increments due to the options being more expensive(high IV). At least I think this is the case, again I am a newbie so if I anyone wants to correct me on this theories please do so...

I do have a bit of a follow up question for either Mr. Consistent or Dagnyt though... Why is it that verticals should be traded over longer periods of time as opposed to over a day or couple of days.

As I went through the last half year back testing verticals call spreads vs just buying a call and vertical put spreads vs just being a put in different scenarios, It appeared that spreads were the better trades for the short term move (day - around 3 days) and it appeared that just straight up calls and puts were better for swing trading(3 days - 10 days)...It seemed that spreads limited your losses on days when your were wrong, and helped you gain almost equally and sometimes better than straight up calls and puts when your were right in the short term....But due to spreads maximum profit it appeared that for the longer term swing trading(3 - 10 days) that just straight up calls were better as they allowed you to continue gaining and not have to deal with a max profit. So, can you guys tell me why I would want to use spreads for the longer term and not the short term? Or are you guys saying spreads are only better for the long term if I hold till or close to expiration and therefore receive the full credit from the sold option? Again thanks a lot for any help you can provide.
 
Quote from user83248324:

OK, well I am not sure if 1,000 open interest is illiquid for an option or not, but if it is then yes I am getting those spreads on an illiquid option. I basically stumbled upon this as I was just doing practice vertical trades and found it interesting how I would sometimes be winning or losing on both sides of the trade at the same time...usually when this would happen one of the sides would end up going back to positive in a minute or so and even the trade back out. So after seeing this I thought isn't there someone this could be utilized? And it turned out it could and it would be profitable, but I guess it turns out that because of the small amount of options being traded that this system wouldn't really work with real money. Now when I tried to use this on SPY I was not able to due to the near ITM spreads only moving in penny increments, with the options I was trading before the near ITM options were moving in 5 cent increments due to the options being more expensive(high IV). At least I think this is the case, again I am a newbie so if I anyone wants to correct me on this theories please do so...

I do have a bit of a follow up question for either Mr. Consistent or Dagnyt though... Why is it that verticals should be traded over longer periods of time as opposed to over a day or couple of days.

As I went through the last half year back testing verticals call spreads vs just buying a call and vertical put spreads vs just being a put in different scenarios, It appeared that spreads were the better trades for the short term move (day - around 3 days) and it appeared that just straight up calls and puts were better for swing trading(3 days - 10 days)...It seemed that spreads limited your losses on days when your were wrong, and helped you gain almost equally and sometimes better than straight up calls and puts when your were right in the short term....But due to spreads maximum profit it appeared that for the longer term swing trading(3 - 10 days) that just straight up calls were better as they allowed you to continue gaining and not have to deal with a max profit. So, can you guys tell me why I would want to use spreads for the longer term and not the short term? Or are you guys saying spreads are only better for the long term if I hold till or close to expiration and therefore receive the full credit from the sold option? Again thanks a lot for any help you can provide.
More...

You can't say for sure whether your theory works or not until you test it with real money, so until you do it's all guesswork. Getting filled in live trading is not the same as getting filled in paper trading, some trades that work on paper may not work in real life or vice versa...

The reason that spreads are generally held over a longer period of time is the slippage (wide bid-ask spread), which can be quite significant on a single option, let alone on two. Also, since you buy an option and then sell another to offset it, your position is less sensitive to movements in the underlying and, thus, requires a greater move to become profitable. So if you are trying to catch a relaively short-term move in the underlying then you are much better off trading the underlying itself. In addition, a vertical needs time decay to widen out to its maximum value and you have virtually no decay over a single day.
 
Quote from user83248324:

OK, well I am not sure if 1,000 open interest is illiquid for an option or not, but if it is then yes I am getting those spreads on an illiquid option. I basically stumbled upon this as I was just doing practice vertical trades and found it interesting how I would sometimes be winning or losing on both sides of the trade at the same time...usually when this would happen one of the sides would end up going back to positive in a minute or so and even the trade back out. So after seeing this I thought isn't there someone this could be utilized? And it turned out it could and it would be profitable, but I guess it turns out that because of the small amount of options being traded that this system wouldn't really work with real money. Now when I tried to use this on SPY I was not able to due to the near ITM spreads only moving in penny increments, with the options I was trading before the near ITM options were moving in 5 cent increments due to the options being more expensive(high IV). At least I think this is the case, again I am a newbie so if I anyone wants to correct me on this theories please do so...

I do have a bit of a follow up question for either Mr. Consistent or Dagnyt though... Why is it that verticals should be traded over longer periods of time as opposed to over a day or couple of days.

As I went through the last half year back testing verticals call spreads vs just buying a call and vertical put spreads vs just being a put in different scenarios, It appeared that spreads were the better trades for the short term move (day - around 3 days) and it appeared that just straight up calls and puts were better for swing trading(3 days - 10 days)...It seemed that spreads limited your losses on days when your were wrong, and helped you gain almost equally and sometimes better than straight up calls and puts when your were right in the short term....But due to spreads maximum profit it appeared that for the longer term swing trading(3 - 10 days) that just straight up calls were better as they allowed you to continue gaining and not have to deal with a max profit. So, can you guys tell me why I would want to use spreads for the longer term and not the short term? Or are you guys saying spreads are only better for the long term if I hold till or close to expiration and therefore receive the full credit from the sold option? Again thanks a lot for any help you can provide.
More...

A) I believe (though not 100% sure) that TOS paper money fills your order at “midprice”, which makes it seem easy to get fills. But real world you don't get fills at midprice

B) Don't attempt to arbitrage options on intraday prices, market makers take good care of that : -)

C) I think Dagnyt gave you very good answer why spreads are not good for day trades, not only you would have to pay spread four times, and even if the trade goes in your favor, the Delta is low and consequently the spread will increase in price only by negligible amount. Go to TOS analyze tab, put on simulated vertical spread and play with adjusting the days to expiration and so on. You'll see that verticals start performing best as expiration approaches, as the extrinsic value from the short option disappears, as the time decay accelerates as the expiration approaches. Verticals are best to hold to the last week (providing you don't have to exit by being totally wrong on direction)

D) If you want to daytrade, just use stocks and if you make profit and believe the move will continue, then at the end of the day get rid of the stock and with the profits you can buy an options and you'll have a risk free trade. If the next day the stock gaps against you, you couldn't care less. That's one way to combine daytrading with option trading.

Best Regards :)
 
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