Vertical spread risk/reward?

Quote from trefoil:

spindr0 already beat me up, gently, for this one. I understand the risk is smaller (now), but in options, as in everything else, low risk = less profit, except as these are options it also = less probability for profit.
Given that, I'm curious about your statement that ATM credit spreads have a better long term expectancy.
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"Low risk = Low reward" That is another untrue statement. Well, I shouldn't say untrue. It is a very misused statement and is only accurate under certain conditions. A more accurate statement would be that "lowER risk = lowER reward if positions are entered randomly and the vehicle is the same. That only applies to those who have no concept of how to determine expectancy of the strategy.

OTOH, edge creates greater positive expectancy over time, this increasing positive expectancy results in lower risk and higher reward. The world is replete with examples where the profit for three different investments is similar but the risk varies wildly. The difference between the ignorant and the savvy investor is that the savvy investor realizes which of the three entails the lowest risk.

Anyway, not sure that I have time to argue the merits of all the different options strats, and this forum is filled with my opinions from the past several years as they were developing. These days I only come around if I get bored.

In a nutshell, the low risk of OTM credit spreads is an illusion. In reality you can run the stats yourself and you'll realize that with random entry the OTM verticals lose more $ over the long term than the ATM verticals. This all has to do with the gamma curve. It is very hard to contain the risk of a large adverse move in a OTM credit vertical. The velocity of losses increases as the underlying moves against you. OTOH, it decreases in an ATM credit spread.

You aren't going to believe anything I'm telling you unless you actually run all the calculations yourself. OTM credit spread traders are a stubborn bunch.

I used to make a very good living in credit spreads of all kinds, so I'm certainly not biased against them, nor am I ignorant to their usefulness.
http://www.elitetrader.com/vb/showthread.php?s=&threadid=63020
I've since moved on to strategies that provide much greater profit at significantly reduced risk.
 
Quote from Cache Landing:

"Low risk = Low reward" That is another untrue statement. Well, I shouldn't say untrue. It is a very misused statement and is only accurate under certain conditions. A more accurate statement would be that "lowER risk = lowER reward if positions are entered randomly and the vehicle is the same. That only applies to those who have no concept of how to determine expectancy of the strategy.

OTOH, edge creates greater positive expectancy over time, this increasing positive expectancy results in lower risk and higher reward. The world is replete with examples where the profit for three different investments is similar but the risk varies wildly. The difference between the ignorant and the savvy investor is that the savvy investor realizes which of the three entails the lowest risk.

Anyway, not sure that I have time to argue the merits of all the different options strats, and this forum is filled with my opinions from the past several years as they were developing. These days I only come around if I get bored.

In a nutshell, the low risk of OTM credit spreads is an illusion. In reality you can run the stats yourself and you'll realize that with random entry the OTM verticals lose more $ over the long term than the ATM verticals. This all has to do with the gamma curve. It is very hard to contain the risk of a large adverse move in a OTM credit vertical. The velocity of losses increases as the underlying moves against you. OTOH, it decreases in an ATM credit spread.

You aren't going to believe anything I'm telling you unless you actually run all the calculations yourself. OTM credit spread traders are a stubborn bunch.

I used to make a very good living in credit spreads of all kinds, so I'm certainly not biased against them, nor am I ignorant to their usefulness.
http://www.elitetrader.com/vb/showthread.php?s=&threadid=63020
I've since moved on to strategies that provide much greater profit at significantly reduced risk.
More...

I actually favor vertical debit spreads over credit spreads, and I'll occasionally do a backratio if I'm really confident of a large move, which doesn't happen often. I only got into credit spreads around the middle of last year, and am still only fooling around with them, which accounts for my misconceptions.
I can see your point about the velocity of losses above. I've also noticed in backtesting systems that there are some systems that have lots of winners and not a lot of losers, but that lose money anyway, and I've been suspicious all along that this is the case with trying to do OTM credit spreads, so I'm paying attention carefully to what you're saying.
The other interesting thing I've noticed, and I'm not sure if this is just because I started on them or because it's really true, is that more and more people seem to be trying OTM credit spreads. Given what happened in '08, that seems odd. Of course, here I am, checking out the same thing, so I include myself in this set of people.
 
Quote from trefoil:

The other interesting thing I've noticed, and I'm not sure if this is just because I started on them or because it's really true, is that more and more people seem to be trying OTM credit spreads. Given what happened in '08, that seems odd. Of course, here I am, checking out the same thing, so I include myself in this set of people.
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Trading credit spreads has the potential to provide high return (5%+) per spread, high probability of success (90%+), but when they lose, the have the ability to wipe out several months profit. Management of the spreads becomes critical in reducing the impact of these inevitable losses.

If the trader adds the companion credit spread to form an Iron Condor then only half of the spreads are at risk from a black swan day. Installation of circuit breakers may limit the losses to 20% to 30% of the maximum possible loss. Furthermore, the spreads that did not get taken out are likely to be at their maximum potential profit. They can be closed and, when the market settles a bit, rolled to a new spread nearer the underlying instrument price. Nearer because time has passed and time decay is in play. Rolling lets you add additional profit with the same amount of quarantined funds.

If the trader keeps a significant portion of his account in cash (20% to 25%) then even a double black swan day leaves you bloody but unbowed. A double black swan day is when the market takes out half your spreads swinging one way and then swings violently the other way and takes out the other half.

I make my living trading Index Options Credit Spreads enhanced by the formation of Iron Condors when market conditions are right. I've engineered quite a few protections to reduce the risk of significant loss mostly as a consequence of the feedback I get from forum posters in my journal. They have made me smarter.

Live long and prosper.
 
Cache Landing's journal (linked to in his post) has an analysis from a poster named momoneythansens (good name) that gets into what Cache Landing alluded to here re ATM and OTM credit spreads. Interesting stuff, actually.

Howard: as I've said before, so far what I'm finding is that getting that "cheap hit of high gamma" from the weeklies helps tremendously with risk mgmt of ICs. It may be that having these available may allow me to comfortably trade these for some add'l income. We shall see. I'm not really looking to "go live" for at least a year, so I have lots of time to work with it.
 
Quote from HowardCohodas:

And they are?
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Sorry. I was once quite generous in helping others to become profitable. I'm still very willing to be helpful for those trying to find profitable strategies, but I can't in good conscience divulge the details of my current strategies. Too much $ at stake. Maybe one day when I decide that I've done well enough and need to relax.
 
Quote from trefoil:

I actually favor vertical debit spreads over credit spreads, and I'll occasionally do a backratio if I'm really confident of a large move, which doesn't happen often. I only got into credit spreads around the middle of last year, and am still only fooling around with them, which accounts for my misconceptions.
I can see your point about the velocity of losses above. I've also noticed in backtesting systems that there are some systems that have lots of winners and not a lot of losers, but that lose money anyway, and I've been suspicious all along that this is the case with trying to do OTM credit spreads, so I'm paying attention carefully to what you're saying.
The other interesting thing I've noticed, and I'm not sure if this is just because I started on them or because it's really true, is that more and more people seem to be trying OTM credit spreads. Given what happened in '08, that seems odd. Of course, here I am, checking out the same thing, so I include myself in this set of people.
More...

It is just a cycle like anything else. If you have the energy you can ready all you ever wanted to know about credit verticals from my journal and Optioncoach's journal. All arguments have been made and that was during that last big credit spread boom. It should be noted that the gurus from those threads no longer trade credit spreads. This is because they always discover that there are much better strategies out here.

Long term profitability is only indirectly related to probability of profit. The important factor is expectancy. If your strat results in positive expectancy then you have an edge. No edge = no sustained profitability. The unfortunate thing about strats like OTM credit spreads is that a person can go for quite some time without losing money. This gives many the false impression that OTM credit spreads are long term profitable in and of themselves. That is absolutely not the case. OTM credit spreads have a negative expectancy. Any edge comes from the directional (or vol forecasting) skills of the trader.

When you realize that point, then you start to realize that there might be better ways to trade. If your skill is direction, then there are better strats for direction. If it is vol forecasting, then there are again better strats.
 
Quote from Cache Landing:

It is just a cycle like anything else. If you have the energy you can ready all you ever wanted to know about credit verticals from my journal and Optioncoach's journal. All arguments have been made and that was during that last big credit spread boom. It should be noted that the gurus from those threads no longer trade credit spreads. This is because they always discover that there are much better strategies out here.

Long term profitability is only indirectly related to probability of profit. The important factor is expectancy. If your strat results in positive expectancy then you have an edge. No edge = no sustained profitability. The unfortunate thing about strats like OTM credit spreads is that a person can go for quite some time without losing money. This gives many the false impression that OTM credit spreads are long term profitable in and of themselves. That is absolutely not the case. OTM credit spreads have a negative expectancy. Any edge comes from the directional (or vol forecasting) skills of the trader.

When you realize that point, then you start to realize that there might be better ways to trade. If your skill is direction, then there are better strats for direction. If it is vol forecasting, then there are again better strats.
More...

Interesting. You may have saved me a year of investigation.
BTW, I'm about 40 pages into your journal right now. Lots of good stuff in there.
 
In low volatility times such as this (although is very possible for the VIX to drop to 10), it's probably best to buy otm puts with at least 3 month exp... If that's too risky, albeit it's pretty much the staple of what Nassim Taleb's Empirica fund did to capture kurtosis/fat tail events, then atm bear put spreads is the way to go.

When the VIX is on an upward trajectory, then atm bear call spreads would be best....

K.I.S.S.

Walt
 
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