How to hedge credit spread option strategy?

Yes thank you. And may I add: How I manage such a trade if it goes against me.

 

This is an extremely grey area to answer,

because it's highly subjective...on your risk/reward tolerances, and your personal viewpoint/future convictions,

We all have crystal balls -- but some are more clear and foggy than others,...try to have a dynamic crystal ball, you have to be able to take subtle signs of what Miss Market is trying to give you,

Don't think you are right. you are not. -- Miss Market is always right. and she can be weird, and bitchy and moody,

Just because an economic report is good, or you give Miss Market flowers and chocolate...Don't think or assume everything will be happy and go up,

 

Fantastic!

 

Not necessarily. You can be on either side of the market (and with either puts or calls). Strictly as a hedge against a long position in the underlying doesn't really make a lot of sense because you're giving away most of your absolute downside risk protection to save a little up front. A credit spread is (usually) a net-short position where the long OTM option is the hedge against the short ATM/NTM option. Or you can do what @tommcginnis is suggesting and be price agnostic on a volatility play (as an aside, Tom, can can this be flipped where you're short the further out expiry from ATM so it decays more with a relatively large price move?).

My current strategy (on hold for now for vacation) is to use a credit spread to pick up the decay on my core positions, and hedge them with a debit spread. Like for example, a $2k NTM credit spread on puts for MO and AAPL hedged with a $1,400 put debit spread on SPX that's slightly further OTM. That way, a systemic move against me give huge gains to offset the losses (in that example in a 1.5% move down, I'd expect losses of around $9k from the core positions vs. about $7k gains in the SPX). But since I never hold till expiry, in the above, I'd almost certainly close with a stop--ideally, MO and AAPL would lag the S&P and I'd be able to close the SPX spread for more than the losses on the MO and AAPL stops.

It's actually possible to open a credit spread where the time decay works against you too. That's purely a price play. For the above example, think SPX call spread long 2400, short 2390. In a perfectly liquid world in a perfectly symmetrical market this should be identical to the long 2400 put / short 2390 put. All things being equal, I'd prefer the debit spread in this case. The only time I'd do this is on something without liquidity on one side of the market (like LUV 7/21 expiry favors calls from a liquidity standpoint).

I like spreads in general because of their versatility. I'm always discovering new ways to use them.

I'm still trying to get my head around Tom's calendar spread strategy--very tough to view in your mind!!! But from what I see, it's awesome if you get good fills. I've tried for the last week or so to get a fill on one of those positions, and didn't get any nibbles. I've incidentally legged into these as the final leg of a diagonal spread run (with LOTS and LOTS of profit in-hand), but never thought to try it from jump. Even on symbols like MO, KO, and JNJ, the spread / fill will determine if this strategy is viable--it's definitely a winner if you buy at the bid and sell at the ask.

 

But I like directional bets because I like convexity and how I manage when it goes against me allows me to be a successful full time options trader.

Best to you.

 

Sorry I miss-spoke. You are right. But my question is still the same.

 

Thanks. I appreciate you taking the time to answer and to clear up my confusions.

 

I like how these look when I'm opening positions too. I have to constantly remind myself of the time I used to trade in debit spreads and looked at losses > commissions. Which was great--I had a consistent strategy, I was just on the wrong side of it.

And sorry, I spent a lot of time answering your first, and not answering the second. As best I understand, are you asking why open a position at all if I'm not confident of market direction?

The short answer is I suck at making accurate market predictions. To win on a debit spread, you need to be correct on direction, magnitude, and timing. On the credit spread you can be wrong on one or two of those and still turn a profit.

 

Nah! It's a freakin' spreadsheet. Clickity-click, it's done.
I'm turning next to having it generated (from IB) in real time: "Look, Ma! No hands!"

 

Eeeek! You would *never* want to short the further option -- a recipe for TFD. ("Total Financial Disaster"... maybe.)