Vertical Spreads for Aggressive Growth

[momoneythansens]

Not being confrontational but I would like to add that I think about these positions almost in the opposite way.

My approach is that the "credit" received from the short vertical does not belong to you. It's a temporary loan from the market courtesy of the short box "attached" to the synthetic long vertical equivalent. At best it's an illusion and therefore the mark to market of the position has a higher significance for me, especially if you decide to leg out, take profits early or close before expiration etc.

So turning your statement on it's head: "Most times a loss on an OTM spread is merely a paper loss and won't be realized."

I could assert "Most times the credit on an OTM spread is merely a paper gain and won't be realized."

Granted, the credit is used to lower your maximum risk and you can potentially gain interest on the credit whilst it is being loaned to you.

With an account as small as the one you are trading for the purposes of this journal, it hardly seems worth it to opt for the credit spread variety as you won't be able to leverage the loan as much as you might be able to with a larger account. Though that is not a reason not to do so.

Furthermore, from a psychological point of view, especially for novices it might be better to opt for the synthetic debit equivalent as it reinforces the max loss at risk for each given position as that is what comes directly out from the account. With the credit spread, it's easy to focus on the credit received (whilst getting attached to it) and not really appreciate what is fully at risk. I'm certainly not suggesting this is the case for you but it could be an influence for others.

Arguably it's all semantics but I thought I'd throw that out there for people to consider.

Congratulations so far. Off to a good start!

MoMoney.

Quote from Cache Landing:

My account value is not marked to market at the end of each day. I can do that if you'd like but I think it is often counterproductive when dealing with OTM spreads. Most times a loss on an OTM spread is merely a paper loss and won't be realized. Some people find value in knowing what the positions could be liquidated for right now. I do keep an eye on this, but it doesn't take into account any hedging strategies. I find it easier to keep regular posts on what I am thinking about my current plays.

 

[momoneythansens]

LOL. I'll probably stick that in my first post if I ever start my own journal.

Quote from Cache Landing:

We appreciate you guys so much, because we never would've realized that was possible if you hadn't told us. But now that you've delivered your message you'd better go check under your matress to see if your money jar is still there. We know that it's too risky to go more than an hour without checking to make sure you haven't lost any money.

 

[RichardRimes]

I would love for someone to explaine to me what exactly "mark to market" is. I know its been explained to me before but I still don't get it. On my statment I have p/l set to opening p/l and day p/l and when I noticed that the opening p/l would change as the day went by and asked tos "why" (cause I thought it would be value of position on open) they said something about mark to market blah blah blah.... still meaningless to me. as my aunt would say its the bottem line that counts...if liquidated today what would I have.

 

[RichardRimes]

and I REALLY need to start getting a life on the weekends

 

[momoneythansens]

You read my mind, but since I'm here too I can't be the one to tell you!

Marked to market is just what the position is currently valued at i.e. if you had to liquidate right now. It's the paper gain/loss. [EDIT] So your aunt should be trading my account instead [/EDIT]

Quote from DonnaV:

and I REALLY need to start getting a life on the weekends

 

[RichardRimes]

Quote from momoneythansens:

You read my mind, but since I'm here too I can't be the one to tell you!

Marked to market is just what the position is currently valued at i.e. if you had to liquidate right now. It's the paper gain/loss. [EDIT] So your aunt should be trading my account instead [/EDIT]

of course..thats why it changes...I'm trading my aunts account and I have to keep explaining myself ie. that bottom line isn't REALLY as bad as it looks:eek:

 

[cnms2]

Actually it assumes that you get a higher interest (or return) than the interest rate factored into the price of the option you sold. If you leave that cash into your account you'll get a lower interest rate than the one factored into your sold option price. Isn't it so?

Quote from momoneythansens:

... Granted, the credit is used to lower your maximum risk and you can potentially gain interest on the credit whilst it is being loaned to you. ...

 

[momoneythansens]

Yes you're right, the cost of carry is factored into the price of the short box. However, if you use marginable securities as collateral you might be able to increase the "interest" earned over base. The problem being that you won't get 100% equivalent of the full cash amount for collateral. Plus you will always need spare cash on top of the marginable securities in the account for various eventualities. All of which adds up to there being not much benefit to the credit spread variety vs. debit spread on small account sizes such as this.[EDIT]Liquidity and fill issues aside[/EDIT]

Quote from cnms2:

Actually it assumes that you get a higher interest (or return) than the interest rate factored into the price of the option you sold. If you leave that cash into your account you'll get a lower interest rate than the one factored into your sold option price. Isn't it so?

 

[Cache Landing]

Quote from momoneythansens:

Not being confrontational but I would like to add that I think about these positions almost in the opposite way.

My approach is that the "credit" received from the short vertical does not belong to you. It's a temporary loan from the market courtesy of the short box "attached" to the synthetic long vertical equivalent. At best it's an illusion and therefore the mark to market of the position has a higher significance for me, especially if you decide to leg out, take profits early or close before expiration etc.

So turning your statement on it's head: "Most times a loss on an OTM spread is merely a paper loss and won't be realized."

I could assert "Most times the credit on an OTM spread is merely a paper gain and won't be realized."

Granted, the credit is used to lower your maximum risk and you can potentially gain interest on the credit whilst it is being loaned to you.

With an account as small as the one you are trading for the purposes of this journal, it hardly seems worth it to opt for the credit spread variety as you won't be able to leverage the loan as much as you might be able to with a larger account. Though that is not a reason not to do so.

Furthermore, from a psychological point of view, especially for novices it might be better to opt for the synthetic debit equivalent as it reinforces the max loss at risk for each given position as that is what comes directly out from the account. With the credit spread, it's easy to focus on the credit received (whilst getting attached to it) and not really appreciate what is fully at risk. I'm certainly not suggesting this is the case for you but it could be an influence for others.


MoMoney.

I like it when you contribute to the thread. For all those who stumble across this humble little thread, take a lesson from Mo and contribute in a constructive way rather than tearing us (me) down.

Anyway, you have a valid point when you flip my statement around. If my strategy consisted of exiting most OTM plays at a loss if the underlying turns against me, then I would definitely have to agree with you. Psychologically it would be much safer to have a mark to market mentality. I do always say that something is only worth what you can sell it for right now. I guess that statement would also apply here.

Mark to market mentality is just very dificult when dealing with OTM (especially deep OTM) credit spreads. I think an example would make this easier to understand my mentality for all the newbies out there.

Say I got in on a MAR SPX 1200/1190 bull put for a credit of $70/contract. A basic probability analysis says that I am almost 93% likely to expire worthless. Let's say that I am only willing to lose half as much as I stand to gain on the trade ($35). If the SPX drops 10 points on monday then I will be forced to close the position at a loss of $35. That's a shame considering that I am still 55 points OTM and I still have almost a 90% chance of expiring worthless for full profit ($70).

I realize that this example was really dumbed down, but given the recent questions regarding mark to market, I thought I would explain simply. Anyway, it becomes impossible to make an OTM trade with a mark to market mentality. For me it is easier just to know at what point I will adjust the position. Chances are I won't adjust until I am much closer than 55 points OTM.

Also, it is a statistical fact that more often than not the credit on an OTM (especially deep OTM) spread will remain in tact. The problem is the few times that it doesn't, you are potentially losing many times what you stood to gain. Therefore, the minority losses can wipe out the majority gains. Hence, the need to practice sound risk management.

Obviously if this were my real account I wouldn't really be able to consider gaining interest on the credit recieved. In this case its sole purpose is to decrease risk, as the true risk here is the spread minus the credit recieved. You make a good case for the synthetically equivalent debit spread. It is nice for a novice to be able to look at the trade and have a constant reminder of how much they stand to lose. This isn't an issue with me as I will never let a play lose the max amount. I always have some sort of adjustment planned that has more to do with the movement of the underlying than the "paper loss" on my account.

All things being equal, I prefer credit spreads for one reason. I don't like being assigned before expiration. I cannot be assigned early on an OTM credit spread. Many people say that it is very unlikely that you will get assigned early. I used to say that too until it happened a couple times. Since then, I've opted for the credit spreads.

To each his own, but I'll stick with credits for now.

 

[Cache Landing]

Quote from DonnaV:

of course..thats why it changes...I'm trading my aunts account and I have to keep explaining myself ie. that bottom line isn't REALLY as bad as it looks:eek:

I used to have to do the same explaining for people.

"You really haven't lost $1000 YET! We are still OTM, and there's only 2 weeks to go"