Selling credit spreads money management

Discussion in 'Options' started by droid17, Nov 13, 2009.

  1. droid17


    Hi all :),

    I am looking to get your opinions on general bankroll management you guys use. In particular I am interested in selling credit spreads.

    I have found some suggestion using 2% of your capital on a single trade. That sounds safe, but If I wanted to invest something like 200K I would need to find 50 different trades!

    I second question is what is on average your stop loss on buying your spreads back? Again I have read some suggestions citing 4%.

    Any thoughts?


  2. With trading you have to decide how much pain you're willing to endure if all your stops are hit. With option credit spreads, it's how much pain you're willing to endure if they all go in the money.

    If your max risk per credit spread is 2% and you have 50 of them open, you'd be risking 100% of your capital.
  3. This is just an example of how I manage risk but its a very personnal thing and also it is a flexible rule (also commissions vary so you have to calculate with your own):

    yesterday I sold a short put spread for next week on RUT: 530/520 for 0,15$. I sold at 0.58$ and bought at 0.43$. I would not mind putting 20% of my available margin on a single position, it just means your stops must be tighter... Normally what I will do is this: I will only consider the price I buy the short put at (not counting on the long one) to establish stop loss.

    Now this part is fictive, lets say I have a 100000$ portfolio, I would really hate losing more than 2% of that on a single position so:

    20%*100000= 20000$ into RUT, so 10 contracts
    Max loss acceptable: 2% *100000= 2000$.
    I know I sold them at 58$ per contract, so a 2000$ loss is like buying back the contracts at 200$, that places a stop buy at 2,00$ (I would use 1,75$ to be on the safe side).

    Now because of commissions, slippage and all, it is possible that it would but you at more than 1,75$ on the buy, but remember that I am still long 10 520 that will also have increased in value, not as much (see greeks) but still, once sold I have yet -fortunately- never lost more than 2% of my portfolio. Truth is, I never came close to that.

    But that is just an example, also any risk management technique is useless if you don't actually trigger it... Do not try to weasel your way around it, if you hit your set limit, YOU GET OUT
  4. droid17


    Nice thanks heiasafari :) I like your example. So for your set loss trigger do you execute a market buy back of the spread if the trigger is tripped?


  5. Well It would depend on the situation, I usually do not put the buyback order beforehand because I have the luxury to be able to monitor my positions all the time. It would also depends at what speed the market is moving, if it is crawling towards my stops, I would use a regular limit order but if I see lots of velocity normally I will go at market ASAP and let the longs I have run. It has happened that they ended up higher than the buyback when velocity is high.

  6. coffee898


    Hi Droid,
    Good questions. I am attaching a response I posted earlier today in a thread similar to this one. I think it applies here and I hope helps.

    Others have pointed these points out to a degree. In my opinion these are a few things that are crucial for this trading method or any trading.

    Find a trading style that that fits your personality and time availability.

    Always think in terms of “how much can I lose on this trade” as opposed to gaining and mentally be prepared for that loss.

    This goes along with the previous thought but never trade more money than you are comfortable with (the sleep at night factor). Obviously common sense but I think after a while, especially with this style of trading, some folks get lulled into a sense of complacency and ratchet up their accounts.

    I personally only trade the SPY etf knowing there will not be a company specific surprise.

    Have a plan and as long it is solid and you are comfortable with it stick with it unemotionally.

    I also believe with the credit spread/vertical business you need to look at the long-term yearly results not month-to-month or even quarterly. As long as you are positive at the end of the year, in my opinion, is what counts. This style of trading (and any trading plan you come up with) should be fairly monotonous and boring – most good ones are in my opinion.

    I have had 2 positive years doing this +31% 2008 and +40% so far in 2009 and have a system over at Collective 2 called: index spreads. So you can take a peek over there, if you like, for more information on how I personally approach this business.

  7. droid17


    Thanks Dave,

    I will check it out. heiasafari I was thinking more about your strategy. It cuts your lose to a giving amount in this case 2%, but doesn't it Cause you to bail early sometimes?

    For example if you sell a spread with a 80% expected success of finishing above the sold option won't you sometimes buy back early if the it turns bad early. So in reality you cut that 80% success rate down.


  8. Well that is true but if it was easy and/or always clear cut everyone could do it ;) Although like I said it depens on your trading style. I would never enter into a credit spread that has 80% chance of success... I usually put them on with very FOTM puts and very short time left, of course that means low premium and high probability. So the markets need to move alot and fast to get me in my "danger zone" and if it does, my rationale is: hmmm the market has covered alot of ground in a short time, that means momentum, what are the chances it will stop before my actual short strike? Not enough for me so I just bolt...

    Sometimes when I do have some cash available and the momentum seems strong I will cover 2X my shorts, in effect going long and riding the wave...

    The combination of these 2 things saved me last fall and that is why I made money during the crash.

    The point of risk management is to keep you in the game, so yea maybe at times you will run when you should have stood still but hell you will be there to fight another day and thats the main objective
  9. DrvTrader


    Your example is a good strategy and I get your logic. There is just one point I dont get (now this may sound like a newbee).

    For a 530/520 Put spread, you need $1000 margin per contract

    Now if u are using $20000, u should b trading 20 contracts and not just 10.... am I missing something here?
  10. No you are not, you are correct... I made a mistake. Fortunately that was a ficticious example ;) 20 contracts would be more like it, so that means a 1,00 buy back limit
    #10     Nov 21, 2009