Credit Spread Opinions

Discussion in 'Options' started by ktm, Jul 18, 2001.

  1. ktm


    I would like to get some input and opinions with regard to establishing credit spreads. Specifically, the timing and ratios that are typically used and legging in vs. putting it on as a spread.

    A typical credit bull (put) spread that's DITM may only yield .20 with a risk of 2.50. An equally OTM spread could yield a 2.10 credit with the same risk. ATMs are right in between. In the first two examples, a stock may need to move 30% or more for the spread to be a loser or winner, respectively. While these are generic examples and the time to expiration, volatility and other factors can vary the exact numbers, I think these are reasonably typical price assumptions.

    My problem with these numbers and scenarios is that they require a significant move. Even with ATM scenarios, the best spread one could hope for is a credit of about 1.25 (with good fills) while risking 2.50 - or about 50-50. While this is typical and appropriate for most stocks, it requires some additional analysis as to the anticipated direction of the stock.

    When comparing this to legging in, I have repeatedly found that legging in makes more sense mathematically, especially given longer expirations...4-9 months. The answer has more to do with the volatile (non-trending) nature of most stocks. I believe that I can either obtain a free trade or at least cheat (by legging in) to the point of creating an advantage by waiting for the stock to move in my direction before adding the second leg. My question here is: Will I be unsuccessful often enough to NOT make this a profitable strategy?

    I'll use an example.

    ABC is at 15 today. I'm bullish and can establish a credit put spread (sell the 4 month 15P for 2.00 and buy the 12.5P for .80) for a credit of 1.20. I'm even or positive at 13.80 and above and maxed either way above 15 or below 12.5. Instead, let's say I decide to leg in and take the 12.5 Put now for .80...and I wait. Now, if the stock runs away to the upside, I lose. If I can get the move down to about 14, I can probably get another .50 for the 15P and around 12 I could get at least 3.30 for the sell side. In that case, your credit completely covers the cost of the downside. I'm not advocating holding out for a completely free trade, but the point is that the volatility with many of these issues sets up a scenario where the credit amount can be tilted more in one's favor with the help of some technical analysis.

    The same sort of thing can be done on the debit side. If I purchased 5 contracts of ABS Sep32.5C last week at .60 (underlying at 27.5), I could have sold 2 of them today for 1.50 (underlying at 31.75), covering the cost of the entire lot - then sold three Sep 35Cs for .50. I'd be up $150 no matter what happens and could possibly see another $750 if the stock continued my way....with no margin required, my capital free and with a small profit. Am I being too greedy here?

    Given the above I have several questions. Does the risk of legging into to a credit/debit spread in this manner outweigh the sure money of establishing it in one transaction? Given that the blind odds of any stock being above or below today's price is 50-50 at any point in the future and most stocks tend to zig-zag directionally, is legging into a position in this manner something that you would advocate? and why or why not?

    Thanks in Advance

  2. Hey ktm,

    I never leg-in…it feels too risky to me. I am willing to leave money on the table and have sub-perfect trades as long as I get the 'meat' of the action so to speak.

    Also, I think spreads on futures options are more profitable w/ relatively less risk.

    Hope this helps.
  3. FXforex


    SellingNaked ....... you replied to a post made over 12 years ago. :eek:
  4. This has happened several times in short order.

    It must be deliberate.
  5. again!!!!

    Doing my best to resurrect the options sellers on here.

    ...and still bored at work. :)
  6. ofthomas


    if bored, why not create a new thread and discuss the best and proper way to trade options on futures... that would get the options forums going I would think...