Thanks for the explanation. Just want to make sure I have not stumbled inadvertently on a holy grail. LOL. Put on a spread, be wrong , slap on a repair and still get 50:1 Risk reward. I agree with you on the versatility of repairs if you know what u are doing. BTW, risk based haircuts are great but keep in mind that its benefits are more pronounced on certain strategies and minimal on others like flies or condors. This is due to the minimum per contract haircut fee. Ex> If I buy a fly using retail for $300 , I need to have $300, to carry the position. Using risk based h/c, it is probably minimal on the risk side BUT the per contract fee might require trader to have $200?
Yeah I agree, the risk-based haircut excels in large positions and where retail margin is high compared to potential risk-based haircut such as with credit spreads or short premium. For these strategies which require dynamic hedging, the haircut is favored since you get risk reduction from the hedges where retail does not give you such credit. Also cross margining is key for certain products.
Maverick, hope you are still around. The lesson you gave on haircuts was very helpful. If I understand right everyone in a prop shop is sharing each others risk. Is that correct? If so, does that mean everyone in the shop needs to agree on what positions are going to be entered into? Or do you try to judge the additional risk you will be taking on before you let someone join? Would you be willing to underwrite the type of risk being taken in these credit spreads? Not criticizing the strategy, just trying to gain additional perspective.
Coach, To make sure I got it right... you paid a total of (5000+2875) for the put spread, right? Or did you pay only 2875?
I have found that it's also good to put on the pregnant fly (actually I use a 10-point wide debit spread) at the same time the original credit spread is put on...
My answer to this question is of course subject to Mav but here is my take. The prop shop does its best to risk manage each individual to ensure that they do not blow up. And if they do they try and limit their positions so their loss is limited to their own risk capital put in and the shop does not take a loss. Now we share in the risk only in teh sense that if the firm is forced to take a hit, we all might share a tiny % in that loss since we are all members of the LLC. This is possible but rare. Also since there would hopefully be a lot of members, the risk is spread out over 100 or 200 people, you will not be adversely affected depending on your capital size. Now prop traders are not connected so I trade whatever I want and the shop works on managing my risk exposure irregardless of other people. So everyone trades however they want and no need to collaberate at all. It is the job of the shop itself to manage everyone's risk exposure to ensure no one pushes a loss on the company. Now with respect to credit spreads, these are limited risk strategies so if I only risk my capital, the prop shop is extremely safe. Credit spreads are not the risk of the firm as much as they are a risk to me blowing myself up unless I abuse the haircut. More at risk are naked straddle sellers (as one example) who do not hedge and get blown out and lose more than their capital. Then the firm has to abosrb that loss and spread it out among the members. They do not underwirte my risk necessarily, they work to ensure I do not expose them and therefore will cut me off as soon as my position gets out of hand. Prop shops survive through risk management. Like a mortgage pool, 1 or 2% may cause some losses but managing risk correctly means on a whole you are profitable. Mav, I hope I have not distorted it.... lol
This was a hypothetical example but in reality the price paid for the addition of the debit spread is reduced by the net credit recieved from the original credit spread. So whether the net debit is $2k or $20K that is NET of the credit as well. SO using that example, the credit of $5,000 reduced the cost of adding the debit spread from $7,875 to $2,875 hypothetically.
This haircut discussion is interesting.... and so is the "can't trade retail for a living" discussion, but I believe the greatest hedge of all is trading as a hobby/part-time and working part/full time...
Just to add one additional point to all of this discussion. The main reason I became so interested in the PREGO FLY over teh weekend after talking with Charles Cottle as a hedge is solely due to the risk-based haircut. Since the adjustment seriously cuts of my risk and then frees up my capital for more trades I can layer more trades in to collect prmeium and take it to another level. So this is the main reason I sort of revived for myself the discussion of rolling into FLYs. As of now, without a willing compliance department, a retail broker will not allow this at all.
That make a lot of sense. Thanks Coach, and thanks for the journal, the information being posted here is great!!! Jack