C: Your certainly correct about the risk on these credit spreads. Coach stresses risk management over profit, but IMHO the biggest threat to continued success is success. With success comes hubris and this can lead to traders of this strategy becoming complacent and taking on even more risk each month in order to make even more premium. That's why at least for me I need constant reminders to not step out of the comfort zone and to practice good risk management at all times regardless. You mentioned that you posted something way back when. Would you mind reposting or provide the link as I would like to review the data.
On top of that, there is no way to hedge the risk without adding additional risk. I'm not sure a lot of people on this thread understand that. When you put this spread on, you are risking the entire debit on the vertical. Any future action you take simply increases the risk. Small debit spreads are meant to be pure outright bets. They were not created to be hedged around. The best risk management option you have if a spread starts going against you is simply to buy it back and take it off. Of course then one would realize after a few of these losses how little they are getting in return for the tiny credit.
Here it is! For data miners and SPX traders, here are the Expiration-to-Expiration percentage changes for SP500 for the last 10 years. Note that if you were trying to stay out of trouble with your OTM spreads, you would be scrambling like crazy and subject to huge whipsaws during some of those months. Good luck! The data is calculated from the Close on the Friday of expiration week, so it is not quite the Friday morning "settlement" number. Should be good enough to checkout a few "what if" scenarios. Changes greater than 5% are red SPX EXPIRATION PCNT CHANGES Start 19951020 Price: 587.46 Date: 19951117 Price: 600.07 %Change: 2.15 Date: 19951215 Price: 616.34 %Change: 2.71 Date: 19960119 Price: 611.83 %Change: -0.73 Date: 19960216 Price: 647.98 %Change: 5.91 Date: 19960315 Price: 641.43 %Change: -1.01 Date: 19960419 Price: 645.07 %Change: 0.57 Date: 19960517 Price: 668.91 %Change: 3.70 Date: 19960621 Price: 666.84 %Change: -0.31 Date: 19960719 Price: 638.73 %Change: -4.22 Date: 19960816 Price: 665.21 %Change: 4.15 Date: 19960920 Price: 687.02 %Change: 3.28 Date: 19961018 Price: 710.82 %Change: 3.46 Date: 19961115 Price: 737.62 %Change: 3.77 Date: 19961220 Price: 748.87 %Change: 1.53 Date: 19970117 Price: 776.17 %Change: 3.65 Date: 19970221 Price: 801.77 %Change: 3.30 Date: 19970321 Price: 784.10 %Change: -2.20 Date: 19970418 Price: 766.34 %Change: -2.27 Date: 19970516 Price: 829.75 %Change: 8.27 Date: 19970620 Price: 898.70 %Change: 8.31 Date: 19970718 Price: 915.30 %Change: 1.85 Date: 19970815 Price: 900.81 %Change: -1.58 Date: 19970919 Price: 950.51 %Change: 5.52 Date: 19971017 Price: 944.16 %Change: -0.67 Date: 19971121 Price: 963.09 %Change: 2.00 Date: 19971219 Price: 946.78 %Change: -1.69 Date: 19980116 Price: 961.51 %Change: 1.56 Date: 19980220 Price: 1,034.21 %Change: 7.56 Date: 19980320 Price: 1,099.16 %Change: 6.28 Date: 19980417 Price: 1,122.72 %Change: 2.14 Date: 19980515 Price: 1,108.73 %Change: -1.25 Date: 19980619 Price: 1,100.65 %Change: -0.73 Date: 19980717 Price: 1,186.75 %Change: 7.82 Date: 19980821 Price: 1,081.24 %Change: -8.89 Date: 19980918 Price: 1,020.09 %Change: -5.66 Date: 19981016 Price: 1,056.42 %Change: 3.56 Date: 19981120 Price: 1,163.55 %Change: 10.14 Date: 19981218 Price: 1,188.03 %Change: 2.10 Date: 19990115 Price: 1,243.26 %Change: 4.65 Date: 19990219 Price: 1,239.22 %Change: -0.32 Date: 19990319 Price: 1,299.29 %Change: 4.85 Date: 19990416 Price: 1,319.00 %Change: 1.52 Date: 19990521 Price: 1,330.29 %Change: 0.86 Date: 19990618 Price: 1,342.97 %Change: 0.95 Date: 19990716 Price: 1,418.78 %Change: 5.64 Date: 19990820 Price: 1,336.61 %Change: -5.79 Date: 19990917 Price: 1,335.42 %Change: -0.09 Date: 19991015 Price: 1,247.41 %Change: -6.59 Date: 19991119 Price: 1,422.00 %Change: 14.00 Date: 19991217 Price: 1,421.03 %Change: -0.07 Date: 20000121 Price: 1,441.36 %Change: 1.43 Date: 20000218 Price: 1,346.09 %Change: -6.61 Date: 20000317 Price: 1,464.47 %Change: 8.79 Date: 20000420 Price: 1,434.54 %Change: -2.04 Date: 20000519 Price: 1,406.95 %Change: -1.92 Date: 20000616 Price: 1,464.46 %Change: 4.09 Date: 20000721 Price: 1,480.19 %Change: 1.07 Date: 20000818 Price: 1,491.72 %Change: 0.78 Date: 20000915 Price: 1,465.81 %Change: -1.74 Date: 20001020 Price: 1,396.93 %Change: -4.70 Date: 20001117 Price: 1,367.72 %Change: -2.09 Date: 20001215 Price: 1,312.15 %Change: -4.06 Date: 20010119 Price: 1,342.54 %Change: 2.32 Date: 20010216 Price: 1,301.53 %Change: -3.05 Date: 20010316 Price: 1,150.50 %Change: -11.60 Date: 20010420 Price: 1,242.98 %Change: 8.04 Date: 20010518 Price: 1,291.96 %Change: 3.94 Date: 20010615 Price: 1,214.36 %Change: -6.01 Date: 20010720 Price: 1,210.85 %Change: -0.29 Date: 20010817 Price: 1,161.97 %Change: -4.04 Date: 20010921 Price: 965.80 %Change: -16.88 Date: 20011019 Price: 1,073.48 %Change: 11.15 Date: 20011116 Price: 1,138.65 %Change: 6.07 Date: 20011221 Price: 1,144.89 %Change: 0.55 Date: 20020118 Price: 1,127.58 %Change: -1.51 Date: 20020215 Price: 1,104.18 %Change: -2.08 Date: 20020315 Price: 1,166.16 %Change: 5.61 Date: 20020419 Price: 1,125.17 %Change: -3.51 Date: 20020517 Price: 1,106.59 %Change: -1.65 Date: 20020621 Price: 989.14 %Change: -10.61 Date: 20020719 Price: 847.75 %Change: -14.29 Date: 20020816 Price: 928.77 %Change: 9.56 Date: 20020920 Price: 845.39 %Change: -8.98 Date: 20021018 Price: 884.39 %Change: 4.61 Date: 20021115 Price: 909.83 %Change: 2.88 Date: 20021220 Price: 895.76 %Change: -1.55 Date: 20030117 Price: 901.78 %Change: 0.67 Date: 20030221 Price: 848.17 %Change: -5.94 Date: 20030321 Price: 895.90 %Change: 5.63 Date: 20030417 Price: 893.58 %Change: -0.26 Date: 20030516 Price: 944.30 %Change: 5.68 Date: 20030620 Price: 995.69 %Change: 5.44 Date: 20030718 Price: 993.32 %Change: -0.24 Date: 20030815 Price: 990.67 %Change: -0.27 Date: 20030919 Price: 1,036.30 %Change: 4.61 Date: 20031017 Price: 1,039.32 %Change: 0.29 Date: 20031121 Price: 1,035.28 %Change: -0.39 Date: 20031219 Price: 1,088.66 %Change: 5.16 Date: 20040116 Price: 1,139.83 %Change: 4.70 Date: 20040220 Price: 1,144.11 %Change: 0.38 Date: 20040319 Price: 1,109.78 %Change: -3.00 Date: 20040416 Price: 1,134.61 %Change: 2.24 Date: 20040521 Price: 1,093.56 %Change: -3.62 Date: 20040618 Price: 1,135.02 %Change: 3.79 Date: 20040716 Price: 1,101.39 %Change: -2.96 Date: 20040820 Price: 1,098.35 %Change: -0.28 Date: 20040917 Price: 1,128.55 %Change: 2.75 Date: 20041015 Price: 1,108.20 %Change: -1.80 Date: 20041119 Price: 1,170.34 %Change: 5.61 Date: 20041217 Price: 1,194.20 %Change: 2.04 Date: 20050121 Price: 1,167.87 %Change: -2.20 Date: 20050218 Price: 1,201.59 %Change: 2.89 Date: 20050318 Price: 1,189.65 %Change: -0.99 Date: 20050415 Price: 1,142.62 %Change: -3.95 Date: 20050520 Price: 1,189.28 %Change: 4.08 Date: 20050617 Price: 1,216.96 %Change: 2.33
Thank you... all I wanted was some straightforward discussion without all the personal attacks (con-man, unethical). Attack the strategy, not me. Thanks again for your input.
Hey Guys, there is a lot of truth on both sides of the argument. But isn't it also true that the appropriateness of a strategy depends on the market environment. Credit spreads have been profitable for the past six months or so, and the results show that it has been a good strategy during this period. Good results however do not negate the future risks in a changing market. When individuals post about letting their short strikes go ITM because they feel the market is about to turn I tend to think more emphasis should be placed on the scary risk/reward profile of these spreads and the need for proactive risk management.
Choad, Thanks for digging up the data. I think there are two take-aways (for me, anyway): 1) There is a time for credit spreads, and a time when they shouldn't be used. In these lower vol times (vol is in the teens), they work with relatively fewer surprises. 2) 5% on a 1200 SPX is 60 points. I typically try to put 50 to 60 points to the short strike when I put the spread on. Now the 5% months were not 1-day black-swan type changes, the 5% was reached over the course of the month. This means theta decay had time to help the position's p/l, so even if the position had to be exited or rolled, it does not mean the month's p/l was not profitable. There is one weakness due to this strategy's skewed risk/reward, and it is the black swan, 1-day disaster, totally illiquid market, scenario. I believe the only way to mitigate that risk with this strategy is to limit position size.
Bingo! I think it would be very constructive if we came up with a set of market conditions conducive to credit spreads and another set of conditions labelled "avoid spreads at all costs".
Liquidating the spread is the last resort for the credit-spreader, as the market on the offset may often exceed the initial credit. Add in the delta position as it trades against you, and the gamma-risk near the strike, and it becomes apparent why rolling seems to be rational to the credit-spreader. But it only seems that way. The only truly prudent method is to avoid the trade entirely. IMO, the only prudent method offering some protection is to trade the weak synthetical-straddle position[bounded by the vertical] -- choosing put-credits for the smile-attributes and selling futures small into the event. Adding option vol is too costly a replication. Replicating gamma would entail too much delta-risk[deep ITMs] -- and you'd be stuck with large deltas and nil gamma on your ITM hedge. Delta overwhelms gamma on the hedge. Trading the synth straddle is a simple matter to solve for the risk at the strike, but you've no way to mitigate it with futures w/o a ton of incremental risk. Best case; you earn on your credit and your small hedge into a moderate decline. I would buy VBI futures or sell index futures small into the event if I were forced to trade these deep otm credits. These positions look juicy solely due to size-traded. They look so terrible on a nominal, one-lot basis that they must be traded large to resemble a reasonable position. Choad's expiration data should scare the life out of you guys. A couple/few consecutive months of 5% or greater and you've blown a few years of credits. I realize it would likely force you to shut down for the Winter, but one hit = one year of credit scraps.
With lower stat vol comes lower implied vols. So the argument is a moot point. When the mkt moves more, you are getting a bigger credit to work with. When the mkt is quiet, you are getting very little to work with. The main issue here is that you are taking substantial risk, regardless of how far OTM you go for very very little in return. I take risks every day in my trading, but I want to get paid for that risk. I'm not going to stand in front of train for lunch money. How far you go out is really pointless. In fact, I would argue that you should not go far out. Take the risk and get a bigger credit. Maybe put the spread on after a large move when you think stat vol is going to calm down some. I still believe that 95% of the posters on this thread are not grasping all the risk that this strategy brings with it.
I think you should attach the historical Vols # across every line. I am pretty sure you will get same risk/reword then .