Bum-- You wrote, "Credit spreads are much less risky & have lower margin requirements." Consider the following modifications to the example you gave: ------------------------------ Here's an example: XYZ trading @100 Sell ten 90/80 put spreads for $2 each. XYZ goes to 80. Trade result: I lose 8 * 10 = $80. Same stock example except I sell 90 naked put for $4. Trade result: I lose $6. Compare: Put spreads lost $80, which is 100% of $80 net margin. Naked put lost $6, which is 7% of $86 net margin. So would you rather lose $80 (100% of trade margin) or $6 (smaller % of margin)??? ------------------------------ The credit spreads had a lower margin requirement while using less leverage [where leverage = total assets / total equity (and assets = notional value)]. Would you still say the credit spread position is much less risky?
You're focused on margin & I'm focused on $$. I'll leave my previous response as is with no further comment.
One common issue I see often among rookies is that the short leg gets exercised mid trade and you are required to purchase or deliver shares that you do not have coverage for dollar wise. Ex. you have $10,000 in account equity and are suddenly required to purchase shares for $40,000 on a exercised short put. This is not a issue among professionals, but rookies and beginners get in trouble all the time.
Compare: Put spreads lost $80, which is 100% of $80 net margin. Naked put lost $6, which is 7% of $86 net margin. So would you rather lose $80 (100% of trade margin) or $6 (smaller % of margin)??? ------------------------------ The credit spreads had a lower margin requirement while using less leverage [where leverage = total assets / total equity (and assets = notional value)]. Would you still say the credit spread position is much less risky?[/QUOTE] That's not a modification. That is entirely changing the question. Why not make it a 1,000 put spreads? -I always thought about $$$ at risk. Liked keeping my margin/var down more for bonus purposes.
If I'm going to compare positions, then something needs to be normalized or everything is apples to oranges. Bum said "looking @ options trading from a % rather than $$ is a mistake IMO." I think looking at PnL (i.e. $$) without regard to $$$ at risk is also a mistake. Using % is one way people normalize for $$$ at risk. You could also normalize $$$ at risk and look at net PnL. Probability of success and expectancy probably play in here too, and the best answer may be that while both spreads and nakeds have their pluses and minuses, neither is better in an absolute sense. The question to answer is which best suits the individual trader and his/her needs/goals.
1- I'll continue to agree with Bum. 2- "the best answer may be that while both spreads and nakeds have their pluses and minuses, neither is better in an absolute sense. The question to answer is which best suits the individual trader and his/her needs/goals." Elsewhere, I keep saying that.