SPX Credit Spread Trader

dagnyt · Sep 25, 2006

Quote from rallymode:

Maybe its just me but if i sit tight for 2 weeks taking all the risk, i am sure as hell going to wait it out a few more days before i offset and give up like 70% of the gains, given market is within my initial forecast. It's this whole get paid for the risk you take mentality that i like to obsess about. Seems quite intuitive to me.
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Once you have held the positon for the 2 weeks you mentioned - and once your position has re-evaluated and you have earned the profit that resulted from taking the risk, that profit is the amount currently at risk - not your original investment. Thus, it's entirely reasonable to do as Phil did - take the nice profit and move on.

It's in the same vein as closing a diagonal and cashing it in for a profit, instead of rolling it into another position with great potential.

If you want to be exposed to all the negative gamma and positve theta that comes with being short options that are near the strike price as expiration approaches, you can simply sell straddles or strangles at a time that suits you. I believe it is a smart move to give up the much higher risk and much higher reward that coems with holding options to the beitter end. It is NOT foolish to close a posiiton for a good profit just becaue the potential remaining profit is much larger than that already earned.

And if you do love to hold out on your short options to the end - that's just one more reason to play with diagonals. They provide an excellent return for the risk taken. Most other spreads do not.

Mark

rallymode · Sep 25, 2006

Quote from dagnyt:

Once you have held the positon for the 2 weeks you mentioned - and once your position has re-evaluated and you have earned the profit that resulted from taking the risk, that profit is the amount currently at risk - not your original investment. Thus, it's entirely reasonable to do as Phil did - take the nice profit and move on.

What nice profit? $1 gained over 2 weeks on this wide CTM diagonal is what you call a nice profit vs the risk taken? There were atleast 2 more easy points to be had here. giving up rewards this easy will def catch up to you over the long term. With what do you intend to cover the loss on the next trade when you guess the direction wrong? Or are you not trading this systematically? I am almost certain phil would've never adjusted had he calculated the credit properly. I guess we have a very different definition of risk/reward. Adjusting diagonals before expiration is shooting yourself in the leg over the long haul, unless of course your underlying prediction is no longer valid. Over the long term, the best expectancy with diagonals is earned the last week of the cycle, not by closing early with favorable market movement. Check it out on your own.

And if you do love to hold out on your short options to the end - that's just one more reason to play with diagonals. They provide an excellent return for the risk taken. Most other spreads do not.

I hate to be negative but, in my opinion, the call diagonals have a poor risk/reward profile even when you account for the potential for better adjustments. Much much better ways to extract similar returns for alot less risk for a similar underlying bet. Again, apparently we see risk/reward very differently

If you want to be exposed to all the negative gamma and positve theta that comes with being short options that are near the strike price as expiration approaches, you can simply sell straddles or strangles at a time that suits you.

what makes you think you are much safer with this wide front month call diagonal? you dont even have vega point against your gamma risk. Atleast with the straddle i will get paid for my risk taken. You are not.

I guess we will agree to disagree on this one.
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Beachie · Sep 25, 2006

This thread does provide lots of info for a new trader and I appreciate it all.

I can barely keep up, but it is fascinating. Currently I daytrade index futures, . . . learning about option spreads.

Questions: Where is the "sweet spot" of a calendar?

What is the best book out there to learn the anwer to a question like that, and to learn things like how best to adjust positions that are going against you, and how to MORPH positions in general.

Thanks

Beachie (lurker)

dagnyt · Sep 25, 2006

Quote from rallymode:

What nice profit? $1 gained over 2 weeks on this wide CTM diagonal is what you call a nice profit vs the risk taken?

First, I do not to CTM diagonals. I do them further out. Second, I hold my positions a lot longer than Phil. Third, the point I was trying to make is that there is nothing wrong with eliminating risk and taking profits. A $1 profit on a $2,500 haircut in 2 weeks is a very good pofit by anone's standards. If you make 4% in 2 weeks, you can double your money every 9 months. Again, ignoring Phil's trade, I tend to take profits early under two conditions: a) the position is too close to the money and the negative gamma is too high, making the residual risk (and reward) too great. I'd rather move my cash into a much safer position (and collect another cash credit for doing so) and b) The markt is running away from my strikes and there is a fair chance that the cash credit I can take right now is going to shrink. If neither condition is met, I hold longer.

But - there is nothing inherently 'right' or 'wrong' with what I do or with what you do. Risk is in the eye of the position owner and if you advise anyone to just hold on a bit longer for the 'easy money' when that person is NOT COMFORTABLE holding, then you are doing a disservice to that advisee.

With what do you intend to cover the loss on the next trade when you guess the direction wrong?

I NEVER guess direction wrong because I never guess direction. I firmly believe that almost no one can do that consistently. What I do is sell puts and calls as far OTM as provides me with a decent cash credit on my diagonal spreads. Any residual credit I get when closing is a bonus - a bonus I expect to earn, but never predict just how large it will be.

Once those posiitons are on, my job is not that of a trader, but that of a risk manager. I'm going to make lots of money from my positions, unless something bad happens. Well, my job is to close positions that are too risky. That means I close when my short strike is breached and I close when a position provides risk I am not comfortable taking - or profits that are sufficient. Again, I am not looking for max rewards. I cut losses quickly and I want steady income. Month after month. Nothing wrong with being a hero, but I am not going to be one.

I guess we have a very different definition of risk/reward. Adjusting diagonals before expiration is shooting yourself in the leg over the long haul, unless of course your underlying prediction is no longer valid. Over the long term, the best expectancy with diagonals is earned the last week of the cycle, not by closing early with favorable market movement. Check it out on your own.

I do not adjust diagonals. I hold or close. Period.

No need to check. The last week obviously provides the best potential reward. But, it also provides a great opportunity for the profit already earned to disappear. The last 2 months provide examples of how that works. My preferred holding period for diagonals is 7 weeks out to 1 week out. I hold for those 6 weeks (on average) and am happy with the results. Look - I do not close positions at random. If they are well situated with respect to how far OTM they are, I hold until 15 minutes before the close on Thursday. I hold as many of my positions as I can. But, I do not want to hold them all. That is my comfort zone. It's obviously not yours. I don't go arountd telling you that you are making a mistake.

I've played the expiraion game to the ultimate whan I was a mrket maker. I've learned the risk is greaer than the reward and I'm very happy to be a conservative, money- making retail customer.

I hate to be negative but, in my opinion, the call diagonals have a poor risk/reward profile even when you account for the potential for better adjustments... Again, apparently we see risk/reward very differently

I find that the OTM call diagonals have been very profitable, and I love the risk/reward profile. Of course, I've had some that ran ITM, so I closed them for losses. But, very acceptable losses and part of the cost of doing business.

what makes you think you are much safer with this wide front month call diagonal? you dont even have vega point against your gamma risk. Atleast with the straddle i will get paid for my risk taken. You are not.

I get paid very well for my risk taken. That risk is not large. Those diagonals are painless to close when the strike is breached, even in an environment of shrinking VEGA. And when I clsoe on Thurs afyternoon, the rewads are very nuch to my liking.

And it's okay to disagree. One thing I know for certain is that anyone who believes he has the best, or only method for making money with options is out in left field. What I do works very well for me. Why would I want to try to do better if it requires taking more risk that I want to take?
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rallymode · Sep 25, 2006

mark,

i am sure someone with your experience can make any strategy work. I was simply saying that if you are going to employ a systematic approach to doing SPX diagonals or any other strat for that matter you are much better off getting paid for your risk each and every time. Murray is doing this month after month, so is phil. That is systematic. I am not talking about crap shot probability bets here and there. While sometimes it may seem "preferrable" to close with small gains, over the long term you are most likely cutting your returns short since there is no way for you to know whether you made the right call until after the fact. You say you dont trade directionally? Well, guess what, you just took a directional bet by offseting earlier.

I guess i look differently at trading the SPX index. To me its all about a systematic approach and probabilities. Sooner or later, losses will come, the goal is to have enough cushion from your winners to offset them. Using a strategy outside of its optimal environment is undercutting your returns and dramatically reducing your expectancy and believe it or not is actually increasing your risk. Notice, i am not saying you will lose over the long term doing it that way, i am saying your returns could be better. One could argue why ever take more risk when there's a better alternative but i have no intention to get into that discussion.

I am sure you out of all people know the last two years have been very lucrative for the net premium seller, but we all know the market isnt always so forgiving to short gamma bets.

As always, its only my opinion.

dagnyt · Sep 25, 2006

Quote from rallymode:

As always, its only my opinion.
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Yes. But a well-reasoned and intelligent opinion.

Mark

tyrant · Sep 26, 2006

I am new to options but I believe with higher rewards comes greater risk. Since almost everybody here seems to think that diagonals are better or more manageable than credit spreads, I would like to know what is the disadvantages of diagonals (compared to credit spreads ) and also under what circumstances will it lose money. The way you guys put it is as though it is quite unlikely to lose if you manage it properly.

Also someone mentions that diagonals are suitable in low volatility environment. So, if volatility goes above, say, 20 for extended period of time, is it better to do credit spreads then? Or is it workable, day in day out, regardless of where volatilities is heading?

momoneythansens · Sep 26, 2006

Quote from tyrant:

I am new to options but I believe with higher rewards comes greater risk.
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Yet more crazy talk.

Since almost everybody here seems to think that diagonals are better or more manageable than credit spreads,
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IMO there are only a handful of contributors to this thread so it's difficult to arrive at any conclusion with respect to consensus. The vast majority are (semi-affectionately) leechers/lurkers

I would like to know what is the disadvantages of diagonals (compared to credit spreads ) and also under what circumstances will it lose money.
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I'm sure someone will answer this for you but IMO it's better to be able to reason out the answers to these questions for yourself

You may wish to invest a few hours in some decent position analysis software and stress test various positions.

Attaining a firm and intuitive grasp of the behavior of options with respect to price, time and volatility will stand you in good stead.

Also someone mentions that diagonals are suitable in low volatility environment. So, if volatility goes above, say, 20 for extended period of time, is it better to do credit spreads then? Or is it workable, day in day out, regardless of where volatilities is heading?
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Once you have a fundamental understanding of the position and a likely forecast for volatility the answer to this question becomes apparent

In all honesty, if you are new to options, I would not be concerning myself with diagonals initially otherwise you could end up in a dangerous situation where you are only able to copy other people's trades without really understanding what you are doing yourself.

In summary, you will either think my comments extremely unhelpful for not answering any of your questions! or you may come back after a few weeks of reading/studying/testing with a lightbulb on or you will just put me on ignore and hope someone else answers.

Good luck!

MoMoney.

rdemyan · Sep 26, 2006

I believe that Sailing (aka Murray) provided an answer to the volatility question a few pages back.

Since I don't have Mo's skills at finding relevant information amongst thousands to tens of thousands of posts, I copy and paste posts that I'm reading and put them in a personal folder under a certain topic, say diagonals.

Suggestion: Search the thread under the name 'Sailing' and you should be able to find plenty of good posts on diagonals.

Quote from tyrant:

I am new to options but I believe with higher rewards comes greater risk. Since almost everybody here seems to think that diagonals are better or more manageable than credit spreads, I would like to know what is the disadvantages of diagonals (compared to credit spreads ) and also under what circumstances will it lose money. The way you guys put it is as though it is quite unlikely to lose if you manage it properly.

Also someone mentions that diagonals are suitable in low volatility environment. So, if volatility goes above, say, 20 for extended period of time, is it better to do credit spreads then? Or is it workable, day in day out, regardless of where volatilities is heading?
More...

El OchoCinco · Sep 26, 2006

Well I took advantage of the upward move to unwind my silly mistake I made yesterday.

So after stupidly adjusting into the OCT ES 1355/1360/1365 short FLY, I reversed my actions and bought back the 1355/1365 wings and sold the SEP EW 1340 Calls again for a small net credit.

So I unwound the position for free (net credit covered commissions and maybe left with me a small amount of change) and I am back into the diagonal because I studied the charts and felt that with a few days left to expiration, I feel 1340 is still a significant resistance point right now.

I had to eat a small loss from making the initial adjustment which ate my entire credit and then some. My goal is to hold to Friday and go for the original profit objective I had when I first put on the diagonal.

So I apologize for splashing my stupid error here and confusing many and thanks to those who jumped on the error and called me out on it.

I believe that I can still salvage the entire position for a profit by Friday as long as the market does not shoot far on this week's economic data. Lots of earnings warnings coming out should balance this out and keep us somewhat flat (1335- 1345).