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Allistah's Weekly Vertical Credit Spread Journal

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Allistah's Weekly Vertical Credit Spread Journal

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  #1 (permalink)
Bay Area, CA
Posts: 136 since Jun 2010
Thanks: 5 given, 64 received

Hello all --

I will be continuing my journal in this thread and the other thread will be closed down. Just for reference, the other thread is located here:

The goal: The goal of this strategy is to sell vertical credit spreads using weekly options.



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  #3 (permalink)
McMinnville + United States
Posts: 4 since Aug 2012
Thanks: 0 given, 4 received

I read your prior thread with great interest.

I sold (naked) straddles and strangles on ES for several years, then got nailed by a couple successive fat tails. Learned an incredible amount in the process and am re-entering trading with credit spreads -- the only way to deal with fat-tail risk unless you can be glued to a monitor 24 hours a day. I also do some direct contract trading in the "swing" time-frame (a few days per trade).

I think you are doing several things excellently. Among other things...

1. You identified, from the very beginning, that the most important thing about this is to have a correct outlook for the instrument and, if you are wrong, adjust -- which, with credit spreads, often means just closing them to avoid maximum loss.

2. You correctly identified that moves against you are easier to deal with if you are selling the ATM option. With OTM options, you pretty much have to close because the risk to reward is too much against you. If selling at the money, you have more wiggle room and, if your outlook for the instrument still holds, may be able to hold the position or just roll it.

3. It is smarter/safer to go with spreads vs what I was doing. I made VERY good money, month after month, until the low-probability moves hit one after the other. I still would have taken losses with credit spreads, but not as big.

4. It is REALLY smart to not put on a trade when you aren't completely confident about the outlook. We'll never be 100% correct, but so many people just have to be in the market all the time, and that (along with over-leveraging) is how people often get wiped out.

The reality with options is that they are a sum-zero game: If played purely mechanically, without any real attention to market direction, judgement, careful order entry, management and such, you'll ultimately be at break even less slippage and commissions. Death by a thousand cuts. But if you can consistently anticipate short-term market direction, as you appear to have a knack for, I think you've got something that can work long-term.

The only thing I'd add to what you are doing is to be mindful of the current implied volatility levels. Credit spreads, even ATM ones, can go against you quickly (for near max loss) if IV's rise quickly. This is really only (mostly) a consideration with your put spreads. The call side has its own problems (the premiums are often substantially lower for the same distance from the strike, but that might help you since you are selling ATM and buying OTM).

Anyway, when IV's are historically low, they may stay low (ideal), but could pop against you. It happened to me, but then I was dealing with monthly options. Maybe it isn't as much a concern with weeklys? I don't know. In any event, one way to protect from that is to go farther out (in time) with your long option. This should reduce your vega exposure compared to a purely vertical spread. But like anything with options, there will be a trade-off. I'd at least study it from the put/bullish side and see how it might have affected your returns over many trades, good and bad.

And there is certainly no reason to mess with what you are doing if it is working for you! It is just something you might think about and experiment with.

Nice journal.

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  #4 (permalink)
Bay Area, CA
Posts: 136 since Jun 2010
Thanks: 5 given, 64 received

Thanks for the compliments. My other thread got messed up and so it had to be closed down. Then I started this one but sort of lost the motivation to do what I was doing and what was lost in he other thread.

I'm still doing these every week. I think that people need to make their own system or method that works for them but I may just post ideas and little tidbits of info that I learn about trading these credit spreads.

One thing that I've done over the last couple of days was to remove all $1 strike stocks from my watch list. Only $2.50 and above. There are only a couple but the most are $5. When trading $1 strikes the commissions are way too much. I was trading 25 contracts on a $1 strike just to make it match a $5 strike. The commissions were around 5.5%! Way too much. I was also getting way too many stocks on my watch list as well and that was preventing me from really being able to spend the time with he charts that I needed. I started to do too much of a shotgun approach and it's not working out so good. I know how to read charts and know when and when not to get into trades. I think I just got a little sloppy with too many on the watch list and then trying to come up with trades. I've cut the watch list way down and I'm hoping things will improve. I'm still maki money but nowhere the 25-40% I was getting before. Going to slow down a bit and get back to those numbers.

Every mistake or deviance from the right path is a lesson only if you pay attention to what the market and your trade results are telling you. Listen.

Thanks for the tip on the IV. I don't know how to really look at that to make that a part of m decision making process. Have any suggestions?

Thanks again for the kind words, I really appreciate it.



Sent from my iPhone

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  #5 (permalink)
McMinnville + United States
Posts: 4 since Aug 2012
Thanks: 0 given, 4 received

(Please forgive any comments here that are obvious to you. I'm including them on the chance that a beginner stumbles across the thread.)

You need EVERY edge you can get.

Ya, the commissions on options can add up and, once incorporated into your calculations, turn an otherwise profitable strategy into a loser. And with spreads, you are obviously doubling that or more. That is one of the reasons I did options on futures instead of on stocks (mostly) -- the fees were smaller relative to the potential income. In your case doing so would also substantially reduce the universe of instruments you are reviewing, which may or may not be a good thing. If your broker gives you SPAN margin on your positions, that can help, as well. It doesn't change your risk/reward ratios, but usually leaves more capital available for other trades.

I might be misunderstanding your comment about $1 strikes vs $5 strikes. For example, SPY has $1 strikes and (I think) is a pretty good instrument for options trading. Closer strike spacing is good when making adjustments and for precisely controlling risk. If you are referring to lower-priced instruments that have $1 strike intervals because their underlying prices are so low, then I'm with you. The per-contract fee is going to be too great relative to the income. A simple filter to use there might be to only include instruments with prices above a specific value (e.g., $50). That should keep you in a range where your per-contract fee doesn't consume your profits.

Fighting for good pricing on order open, any adjustments, and close (unless you are just letting them expire) can also make a huge difference on your profitability. You can usually get pretty close to mid-point pricing if patient (less a nickel or so). Newbies: Never, ever place option orders as market orders. Just the bid/ask spread will destroy pretty much any strategy in the long run. If you can't get pricing near the mid-point, pull the order and try again later.

When I look back at what I did wrong with the strangle/straddle sales (apart from doing them at all), it was that I was not paying enough attention to the current implied volatility as it compared to the historical values. The basic thing to remember is that implied volatilities represent the relative under- or over-pricing of options. If they are unusually low (relative to their recent history for the instrument), they are likely to increase, and vice-versa. Again, for very short term trades like weekly options, this may not be as much of a factor, but every little edge adds up.

You could, theoretically, include the following consideration in your screening: Look for instruments whose current implied volatility is in the top half of its historical range and is declining. This means you are selling options that, at least relative to their historical range, are "overpriced" and actively deflating at a rate faster than their natural time decay. That is probably going to bring up a bunch of stocks that had recent declines (which might not be what you want). Of course, someone could argue that they are "overpriced" for a reason, and that reason is that a large move is expected in the instrument, a move that could hurt your position if it went against you.

There is always another side to the argument.

Again, I'd backtest this to see whether it actually would have made any difference for your particular strategy. Maybe it wouldn't have mattered.

Also, don't feel bad about the fluctuations in your income and performance. The return figures you mentioned in your prior thread were so high that I just assumed they were flukes or maybe were miscalculated. As I mentioned before, options are ultimately a sum-zero game less your fees and slippage. This counts for buying options, selling options, spreads, everything. Your profitability depends on your ability to anticipate the market and manage orders with enough skill that you can overcome the disadvantages. We might get a few great winners (or losers) in a row, but it is unusual to CONSISTENTLY make more than about 6-7% per month (as a percentage of total capital risk) on systematic credit spreads over the long term -- hundreds of trades -- once all costs and losses are included, and even that requires tremendous discipline and skill. That was for "monthlys"; you can probably do a little better with "weeklys." But just 7% per month is an outstanding return for which most people would kill. Anything more than that is truly a superstar-level trader.

Of course, maybe you are a superstar who is just having an off week.

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  #6 (permalink)
Bay Area, CA
Posts: 136 since Jun 2010
Thanks: 5 given, 64 received

Hi there...

What I meant by $1 strikes were the ones that have $1 spacing between strikes. For those at a $1 strike and I get $0.50 credit, it takes a lot of contracts to match a stock or index that has $5 spacing between strikes where I would get a $2.50 credit. Same percentage, but way less commissions. So the first thing I thought was.. Just move the strikes on the $1 strike stocks so that you get a $2 or $3 or even $5 spread. When I do that you don't get nowhere even close to getting a $2.50 credit with a $5 spread on a stock that has $1 strikes. The return on risk goes down hard the further you spread the strikes.

I hope that makes sense. Thats why I've removed all $1 strikes from my watch list. I really need to have that high credit on my trades.

The market is closed and it is Friday. I had a decent loss this week. :-( My overall percentage is now 10% profit. My numbers weren't wrong, I think I just got some damn good weeks with some incredible profits. Not so much these past couple weeks. I had a -14.9% return on risk this week.

I'm bearish on the market for next week. Over bought on the weekly and daily.

I'm trying out some new rules for when it's a green light on the weekly or daily. They need to line up for me to take the trade so I'm playing with some different numbers. Maybe my changes weren't so good this time around. We will see how this next week comes out.

How are your credit spreads working out?

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  #7 (permalink)
Bay Area, CA
Posts: 136 since Jun 2010
Thanks: 5 given, 64 received

Does anyone have any opinions on setting target limit orders to get out for a profit on credit spreads? I know I used to hear a number of people say they get out at 80% profit. What about setting a loss the same way?

Any opinions on profit and/or loss targets on credit spreads?


Sent from my iPhone

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  #8 (permalink)
McMinnville + United States
Posts: 4 since Aug 2012
Thanks: 0 given, 4 received

The CBOE has a great collection of videos on managing options spreads (and about everything else having to do with options trading). They keep on rearranging their web site. Look under the education menu. Look for their "webinars." You may need to set up an account with them (free) to view the videos. See

When to collect profits or limit losses is the art behind trading. There are going to be a lot of different opinions on it, many of which come down to individual personality, the trade duration and a variety of other factors.

Personally, if all looked good, I'd let a short-term trade expire worthless. But there is also a good argument for setting a profit target and closing out when hit so as to avoid a surprise move against you. It hurts to have a trade up 10% and then lose because I stayed in it too long.

On (defensive) adjustments, it depends on how far OTM you set it up. If I set up a trade ATM, I adjust with the market to keep my short option ATM. If I think the market is going to go hard against me (or it actually does), I would just take it off. Of course, it will then reverse itself the next day.

If your spread is substantially OTM, you can't wait for the short strike to be hit, or you'll take a huge loss. I'd have a stop loss figure in mind and adjust or close completely when that is hit. Some manage it by watching delta.

Also, I'd adjust or close if the price action told me my original market assumptions were incorrect.

You asked how my credit spreads are doing. I don't have any open at the moment. I've just been trading straight ES contracts on daily swings for the last few weeks. That has gone pretty well overall, but has been dead for the last few days because the market changed pattern.

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August 14, 2012

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