credit spread vs long/short stocks

Discussion in 'Options' started by adamchubb, Jun 29, 2011.

  1. i mostly trade stocks (long & short). but i'm thinking whether it's a good idea to trade credit spread as well, in addition to stocks. the major benefit is that i can profit from option time decay if the stock doesn't move.

    i've done a test trade on Monday. i've sold a 150/155 call spread on OIH, about 11% yield on margin. but yesterday's move caused me to take it off, ended up losing 9% on margin. That turned out to be the right call. i bought back the spread with OIH @145, and OIH continued to move higher to 147.

    i start to wonder whether it makes sense to go for the time decay. If I want to reward:risk ratio to be at least 1:1, the negative convexity will cause me to have a stop tighter than the upside target, which means i'll have a higher chance getting stopped out of the trade.

    i'd like to hear your thoughts, if you've been actively trading both, or you've tried both but prefer one to the other.
     
  2. I paper traded index options credit spreads for 5 months before moving to small money trading. There is a lot to learn about options in general and credit spreads in particular.
     
  3. daveyc

    daveyc

    The gamma effect is going to far outweigh the theta on those front month spreads so with any significant move you will either have a heart attack or think you are a genius.
     
  4. 489

    489

    If you want to trade the underlying for direction and also want to take advantage of the time decay short options provide, you could simply buy-write your positions. That is, if you are long (short) stock, sell a 2-3% OTM call (put) option a month or two out. Depending on time & vol this may be ~25 delta option when placed.

    If stock goes your way you collect modest premium and the trade-off is that you don't benefit from a move larger than the OTM option strike. If stock moves against you, the option offsets part of your loss. If you want to keep the underlying position for a long time (for divs etc.), reload the option whenever it is not assigned, or roll it prior to it going in exercise.
     
  5. daveyc

    daveyc

    No offense ,489, although these 'covered call' trades are how most begin their option trading careers, its also how most end their option trading careers. Again, no offense. Put the trade on a risk graph to see how.
     
  6. 489

    489

    The original poster's premise was that he already "mostly trade stocks (long & short)". Therefore, options written against these positions act as a hedge, not additional risk.